Free Trade: OIH

Here’s another trade that looks good.

OIH seems to trading in a range so a condor or butterfly might work here, but I am just looking at selling some puts for now.

Sell the Apr 115 puts and buy the April 110 puts for a credit of .56.

That’s about a 12% roi.

Again, trade at your own risk. I am not using real money on this trade.

Fee Trade: PCLN

I’ve been working on a new trading system for credit spreads. This pick came from that system. So far the system has been hitting 90% winners.

PCLN: Sell Apr 210/200 Put spread for .82 credit.

Max Profit $164

Max Loss $1836

Potential ROI: 8.9%

You should take the spread off when it gets to .10, or if you are down 10%.

This is just an example, trade at your own risk.

How Wide Should Your Strikes Be In A Credit Spread?

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:

Free Trade AMZN

An astute member brought Amazon (AMZN) to my attention a week ago. After some uncertainty, I think AMZN is going higher or at least will not come back to the level it was at before earnings. At least until after DEC expiration. So that makes a Put credit spread a good  bet.

Sell the Dec 115 Puts and Buy the 110 Puts. My software is showing you can get this for .64 credit each.  That would be a 14.4% profit. DEC expiration is 12/19. If you can take the trade off for .10 debit, do so.

The expiration day breakeven on this trade is 114.34 and it has a 92.84% probability of success.

Credit vs Debit Spread—Which is Better?

Are you wondering which is better: option trades that result in a credit or trades that result in a debit?  Simply put, you’re asking whether you should choose a credit spread or debit spread strategy.  Let’s consider both options in more detail. 

A credit spread (also called a net credit spread) involves the investor selling one option then buying another option.  The second option is in the same class and also shares the same expiry date.  However, there are different strike prices between the two options.  In this instance, the new investor gets a net credit for entering this position.  He is looking forward to the spreads either narrowing or expiring in order to get a profit.  A credit spread is basically a conservative strategy in investment.  It is designed to earn a moderate level of income while also limiting your potential loss.  In this circumstance, you are buying and selling options on the same index in the same month.  Remember, the only thing different is the strike price.  The most common credit spreads are the Bull Put Spread and the Bear Call Spread.

What about debit spreads?  First of all, investors have to pay to enter a debit spread (or net debit spread).  This option is when the investor buys an option with a higher premium but must sell the option for a lower premium.  How will this bring profit?  Because the investor is hoping that the premium of his two options will widen due to the market.

Another issue to consider is that of what type of strategy you are going for with credit or debit spreads; as in bull or bear?  The bull or bear strategy involves doing what you’re doing—selecting selling two options, but choosing both call or put options, and with the same expiration dates.  (The strike prices can be different)  The basic philosophy of bullish in stocks is that you buy low and sell high, which can be called an optimistic outlook, or bearish, buy high and sell low, which is a pessimistic approach.  Both of these may work with any given strategy.

When you bring credit/debit into the equation, there are more issues to resolve.  First know that with a credit spread, the required margin will be the same as the difference between both strike prices.  This is the most you can lose.  Your capital requirement will be reduced since you can apply the credit of premium to the margin.  Now let’s consider debit spreads on the opposite end of the spectrum.  These are called debit spreads because your broker is actually going to debit your account for the net premium, as opposed to giving you credit.  The most you lose with the debit spread is the premium net.  Gains are limited and this option does not require a margin.

In deciding which works better for you consider the time value involved.  If you know a stock or underlying is going to move in a certain direction and you know to what price a debit spread can result in more profit. On the other hand, if all you know is a stock is going to move in one direction or not much, than you can place your trade in the other direction.

Let’s look at an example. If you use technical analysis, you can determine support and resistance lines, as well as trendlines. Say a stock is trending up and has support at $50 and is trading at $54.39 right now.

You feel the stock is going to go higher but you do not know by when. Your best bet is to sell a 50/45 Put spread. You sell the 50 put and buy the 45 put in the same month. For the sake of the example, you will trade the current month with the fewest days to expiration. As long as this stock stays above $50 you make the full amount of the credit.

If you think the stock is going to go to $60 in 2 weeks, you can use a debit spread. You would buy the 55 call and sell the 60 call in the same month. You would get the max profit if the stock is above $60 at expiration. But if the stock does not move up, your options will lose value everyday and eventually expire worthless.

With a credit spread, if the stock does not move, you still make money.

Basically we are talking about two sides of the same coin. A debit spread for one trader is a credit spread for another.

When Do I Buy Back A Credit Spread?

Here is a question that comes after reading Lesson 2 in my 9 Lesson course on selling options.

When you say, to buy back the option before, the expiration date, don’t you incur additional costs, that reduce your profits even further ?

Good question. In some trades like the Calendar spread you have to buy them back because you don’t want to get long the option. But in an iron condor or credit spread, you can wait and let the options expire. If you buy them back you incur commissions plus whatever you are buying it back for.
 
In many cases it is a question of risk vs cost.  if there is a lot of time left before expiration, you are probably best buying the trade back in case there is a move against you and you end up losing money. On the other hand if you let it expire you can save a few dollars and maybe 1 or 2% points on the trade. 
 
So lets say you it will cost you $20 to buy back a trade, but if the trade moves against you, you could lose $1,000. Do you take your profits or hope for that last $20. Even if the trade moves just once against you in 4 years, you still lose money.
 
Make sense?

Here is a real life example.

On October 12, 2009  I did a credit spread on AAPL. I Sold the Nov 165 Puts and Bought the Nov 160 Puts as protection for a credit of .50 on each spread. There were about 40 days to expiration.

On this trade if the puts expired worthless I would make 11.11% before commissions. (Credit of $50 divided by max loss of $450 per spread = potential return of 11.11%) 

Well AAPL just had earnings yesterday and the stock shot up to about 200 today. This morning, I was able to buy back the credit spreads at .07 each.

So I made .43 per credit spread in 8 days.  That is 9.5%

Why did I buy the spreads back? I could have let them expire worthless. If I did i would make another .07 per spread. But there is still 31 days left to expiration. So I decided to make my profit and money and look for another trade.

Who knows? Maybe AAPL will settle down and I will sell another credit spread on it this month for more credit. Or maybe I will do something else. All I know is that I don’t want to risk losing $450 per spread (anything can happen and APPL could drop in price) to make another $7 per spread.

Yes I did pay the commissions by buying the spreads back. But on each spread I paid $2.50 in commissions.  $2.50 going in and $2.50 coming out which is a total of $5 in commission per spread. So instead of mkaing $43 per spread I made $38 per spread which is still 8.44%.

(That’s why having an option friendly broker is so important. I pay $1.25 per option with no trip charge. If you are paying $10 plus $1 per option or some other crazy commissions then you ae playing a game that is stacked against you. Get a better broker.) 

In my opinion, take off your spreads when they are close to worthless if there is alot of time left. Take your profits. Everyday your money is out of the market is a day you cannot lose it.

This is not to say I never let my spreads go to expiration. Sometimes I do, but not too often on a highly volatile stock.