How Wide Should Your Strikes Be In A Credit Spread?
January 16th, 2010 
Genius Got the following question this week:
First, thank you for providing a great service. I have been trading options for about a year and have learned a lot from your tips and alerts.
Now, I have a question about position sizing. I am trading $100k of my funds using your alerts. When you send out an alert I multiply the number of contracts by 10 when putting on the trade. My question is: instead of just multiplying the contracts, can I use a combination of increasing the contracts and/or increasing the width of the strikes?
For example, if the alert was to sell 2 SPX 1200/1210 Calls, instead of selling 20 10 point spreads, could I sell 10 20 point spreads? What would be the pros/cons of doing something like this?
It seems to me, if I widen the strikes, then when I need to make an adjustment, I could sell the near strike and buy the next strike as opposed to rolling the whole spread. Is there any advantage to this other than lower commissions and (possibly) better fills? More risk? I feel like I am missing something or not really thinking the strategy all the way through.
Thanks,
Adam
My reply:
Allen,
Can you clarify what you mean by “optimal”?
I am also looking for backtesting softwares, any suggestions besides thinkorswim?
By Optimal, I mean the one that I feel is the best to trade. It provide good premium and does not require too much in commissions. But that is only on the SPX. Other underlyings (stocks/etfs) have different “optional” differences between strikes. To discover this, you must become familiar with the underlying by trading it for a while.
I have used OptionVue and Optionetics Platinum website for backtesting. They both work, but I liked the Optionvue a little better. But it was the more expensive of the two.
When i backtest, I like to see the graph as I am in the trade. Thinkbank does not have graphs, yet. They may add it soon. Or if they have i don’t know about it.
Nice info…
Could you elaborate on “break even” above. How do you calculate this. And what is it’s importance. Or is this listed elsewhere on your website? Thanks
The break even would be the price at expiration where you would not make or lose money on the trade. I cover breakevens more in detail in my free email course which you can sign up for on the homepage.
This question was asked once before; but, I never saw your
response. What do you think of the following strategy?
I sell slightly “in the money” naked PUTS on ETFs and stocks. If the underlying is assigned to me, I sell slightly
“in the money” covered CALLS. Does this make sense to you?
With a high VIX and a stagnant market, I think I am making
money. I choose expirations approx. 4-8 weeks to maturity.
If the Calls are not assigned to the buyer, I continue to
sell Calls again and again on the same securities I hold.
That is an interesting trading style. I would have to do some testing on it to see if it makes sense over the long term. The problem comes when you have a major drop in a stock. That will not only force you to buy the stock at a high price when it is much lower, but then the premium you will get from the calls will be much lower because the stock price is lower. For example, I did covered calls on LVS a couple years ago (which is about the same as what you are suggesting) and the stock dropped all the way to under $2 (from $17). I was getting like $20 for selling a near month call. Compared to the loss it was peanuts. Thankfully, the stock rallied and is now above when I bought it, but it took two years to get my money back. With your startegy as soon as you get behind in a trade it will take a long time to get back to even
If I open a call credit spread at 1200/1210 at $0.60 credit then the breakeven would be 1200.60 less commissions (probably 1200.58). You indicate breakeven of 1200.30 which doesn’t look right.
I used the analyze graph on tos to determine the breakeven. I admit that I did not do the math myself.
I like to use the smallest spread the underlying offers. I find I get the best ROI even when including commission costs. The other benefit is better protection as you indicated in your response.
That’s not always the case. I suggest checking different strikes before placing the trade unless you are very familiar with the stock.
You are correct. It definitely is not always better, but rather often is. I would first determine how far OTM I want to place my spread (delta, ROI, etc.), then check the mid prices on the different spreads.
There is nothing written in stone. You must always do your due diligence
for me …doing 20 lots…a 5 pt spread = $10000 margin
per trade (regardless of tte)…easy for this math-challenged trader to keep track of….Traderkip