timing in taking profit in spread trade

Discussion in 'Options' started by Fish&Trade, Dec 8, 2008.

  1. I have been trading simple call and put options for a few years and for the past year I ventured into bull and bear spreads. At present I have a bull call spread showing some profit. The call option leg I bought has some nice gain, however the call option leg that I sold ( at higher strike price ) also appreciate in value, making the unrealized gain of this spread trade quite small. My question is --- is it for spread trade our aim is to hold on to expiration for maximum gain or should I closed off the trade when there is profit. Actually I have one bad experience that the bull call spread expired without value when the stock come back down again during expiration month. Also in general is spread option trade not that appropriate in volatile market?
  2. 1) The spread trade reduces risk and it also reduces profit potential.

    2) When you trade (either to open the position, or to close it), DO NOT pay the offer and sell the bid. When you submit an order, submit it as a spread (or COMBO) order.

    Try to get a price close to midway between the bid and offer. In other words if the spread is $2.00 bid and $3.30 offered, try to sell a bit below the midpoint of $2.65. Perhaps 5 to 15 cents below. That will leave more of the profit for you.

    3) In general, holding through expiration is a BAD idea. At some point you will earn a profit that satisfies your needs. When that happens, it's time to enter an order to exit the trade. Again - not a market order, but a limit order. If you are in no hurry, try to collect an extra nickel or two. But don't be stubborn.

    4) You must understand that there is no 'rule' that fits every trader. Your individual comfort zone is what matters. At some point, the risk of holding outweighs the thoughts of earning additional profits.

    5) Spread trades are always appropriate for risk reduction. Yes, it's more difficult to exit the posiiton, but in return, you lose a lot less when you are wrong.

  3. Mark, thanks for the advice. I know and appreciate the fact that option spread is less risk and therefore less reward than pure option call or put plays. In the past I have a couple of bad spread trades because I ddin't close them at appropriate time. I suppose its because psychologically I think "if this is just a call option than I can now close the trade with a decent profit, but with this spread trade, I only can get a gain of ---- , I better wait and see ". Yes, I think greed come into play here.

    Talking about submitting the spread trade as a combo order, I use IB and can put through an option spread trade as a net debit or credit order. You talk about submitting a bid a little bit below the midpoint -- and that's important. Because I used to submit an order with a price a little bid under the ask and use to get filled immediately. I think I will go to the mid-point next time.
  4. It's really trial and error.

    Bid (or offer) something. After a while, bid a nickel more. Keep raising bid until you reach your max price. Don't begin near maximum price.

    IB gets pretty good fills, so that should not be a problem.

    Good luck.

  5. Yep, I'll second that.

    Always enter as a spread, always try to get a fill at the mid at first. If you're not getting filled after a few hours, adjust the order a little at a time until you're either filled or you give up. Sometimes the MMs just won't give it up and you have to let it pass.
  6. xtanda


    Below is my trading plan in regard to option spread. If you follow it and make small fortune, buy me a beer someday...:D All comment welcome ! (I attach my excel spreadsheet if anybody interested)

    1. Determine the maximum loss and maximum profit.
    2. Set your target on the range from (1) above
    3. Monitor price movement and stick to the trading plan
    4. Grab "bonus" profit

    1. Determine the maximum loss and maximum profit.
    For spread strategy, we know that the maximum profit is to let both legs of the options (written one and bought one) expired worthless.

    Net Profit = Max Profit - Entry Cost

    where entry cost is the brokerage + clearing house fee for 2 legs

    The maximum loss is:
    Net Max Loss = The Spread + Entry Cost + Exit Cost - Max Profit

    where exit cost is another 2 legs (selling your bought option and close out your written option)

    For example,
    • if the ROI is around 25% (which is quite average) - $1 spread give you 25c profit</li>
    • if you have 10 contract (each contract is 1000 share in Australia, not 100), the profit is $2500. The brokerage is around $100 (for both leg) or about 5% which is acceptable
    • Net Max Profit is $2,400
    • Net Max Loss is $10000 + $100 + $100 - $2500 = $7,700.

    So in this example your possible outcome of this trade is within -$7700 to +$2400

    But if you have smaller contract, do another calculation like above with smaller contract and you find that the brokerage cost is eating your profit significantly

    2. Set your target on the range
    Say you want at least $1900 in profit ($500 or around 20% off from max profit) and max loss is $1400 (always make your profit higher than stop loss - you will be profitable in long run)

    3. Monitor price movement and stick to the trading plan
    • if the price move in favor of your position (move up for bull put spread -or- move down for bear call spread), check how much needed to buy back your written option. If it's below $500 (see above), close it.
    • if the price moves against your position, always check the difference between both leg as if you close them all. If it is above $1400, close them out and you're out-done.

    4. "bonus" profit
    once you have closed the written option (you achieve your minimum profit) - do not sell the bought option yet. let it run until finish see if you can grab additional profit should the market bounce back against your initial position.
  9. xtanda


    Yup you don't need to. just a habit of me to have predefined plan (pdf format usually) to refer to during the months of the option.

    Agreed!! :) Unfortunately, that's we have here. The "full service broker" will charge at least $75 + $1.1 each contract for clearing house fee. The "online/discount broker" will charge $35 + ACH fee per contact.

    I have US account as well which have a lot much cheaper brokerage, but the bank always slug me with hefty overseas transaction fee and not to mention this volatile exchange rate. Not ideal for trading local option/stock.

    If the price goes up(or down) so that we can cheaply buy back the written option, then the protective option (which is more out of the money, will even much cheaper to sell), better hold that one off to anticipate bounce back. work so well so far....

    for JJacksET4
    You are right, sorry.

    I was talking "credit bull put spread" and "credit bear call spread" in particular. Hope this explain some points....
  10. Thanks JJackET4 for clarifying my question -- what I have in mind is about the debit spread trade ( be it bull call spread or bear put spread ).
    Yes, for net credit spread trade the aim is to have both legs expire worthless and thank you all for giving me some ideas about trade adjustments and closing out spread trades.
    #10     Dec 9, 2008