Skip to main content

Spreads vs. Longs/Shorts

So I know we've talked in the past about the benefits of the defined risk/rewards that spreads offer versus just being long or short the options, and we've talked about the differences between paper trading and actual trading. Now that I've had some experience with actually trading spreads this is what I've learned: the defined risk/reward of a spread really only applies if you carry that trade until expiration. Between the changing volatilities, large BxA spreads, and depending on how much time is left, your underlying could be exactly where you thought it would be but you can't exit the trade for the profit you anticipated.

Example: You buy the 100/105 3-month call spread when the underlying is at 100, it shoots up to 105 tomorrow. Because your moved happened faster than anticipated you still have roughly 90 days until expiration so closing out the trade will not yield the max $5 of the spread. Had you just bought the 100 long you can close that out for a minimum of $5 intrinsic value. A personal real world example for me is I have a bull put spread on SPY 106/105 for this month, I think I paid .25 for it. During the dip on Friday the SPY went below 105, but I wasn't able to capture the max .75 profit on the trade because vol increased, the BxA spread increases as we're headed down fast, and I've still got 14 days to expiration. I've also got a MET bull call spread 12.50/30 and the stock has been above $30 for months, but the wide BxA spread and theta left in that trade only offers me a return of $15 instead of $17.50.

So my takeaway that I'll keep in mind when pursuing spreads in the future is to understand that if you want to take the trade off early you'll have to leave some of the profit on the table. You alternative is to take on more risk and just go long or short instead of using a spread. I don't believe this is a right or wrong scenario, just a risk/reward trade off.


Comments

Post a Comment

Popular posts from this blog

WOW! I think that sums it up

Many of you have been reading this blog may have noticed that my blogging frequency has increased over the past few weeks as I got short the market. As you can imagine I am down money since getting short the market, this is the time when most people pull away from posting. But my goal is to stay active and involved and show you that trading is not always rainbows and butterflies. It is times like these that the things I have been sharing over the past couple of weeks are so important. You need to trade small relative to your account. I have a decent short position in the market and my portfolios are set up to make some awesome returns if we finally turn lower. But something I would like to point out is that my account is 70% Cash.  I learned a long time ago how important it is to live by the rules you preach. Because of my discipline I am able to continue to hold my positions, I have time and capital on my side. I can't stress enough how important it is not to get to big....
Post a Comment
Read more

Stay Small, Stay Out of Trouble

To expand on my post from yesterday about patience. I want to talk about a very important element that allows patience in a position, and that is staying small. If you trade too big RELATIVE to your personal account size, you are likely to be forced to exit the trade before the trade works in your favor. Many trades myself included have all experienced the pains of trading a position way too large given our account size. There is this predisposition out there that the only way you are going to make money in the financial markets is if you are trading 10 lots of options and 1000 shares of stock at the time. This is not the case, and if this is your mentality you will likely ensure yourself trouble. We have all read the stories of traders blowing up their account. I personally think a good rule of thumb is to not risk more than 5% of your account value on any one position. Good Luck Trading! In The Money Trades And 1 favor that we ask:  If you like the hard work w...
Post a Comment
Read more
more good news from FXStreet : Tom Fitzpatrick, senior technical analyst at Citibank in New York. Monday, July 15, 2002 "Parity is a psychological, not a technical level...and whether we pause around parity or not, we are likely to see significant further dollar losses...Our initial target is $1.03 to $1.0450. If that level is taken out, it actually casts a question mark against the whole of the dollar's rally of the last seven years, and could open up a full-blown bear market for the dollar." Julian Jessop, chief European economist at Standard Chartered Bank. Monday, July 15, 2002 "The dollar is under pressure from everything from economic problems to asset reallocation away from the U.S. and corporate accounting problems. It's difficult to see any positive factor for the dollar at the moment. The root of the problem is the U.S. current account deficit. If the U.S. doesn't have to attract an enormous amount of foreign capital, people wouldn't have to wor...
Post a Comment
Read more