Showing A Loss Before Expiration

Credit Spread is Showing a Loss

“The credit spread is showing a loss”. Why is this trade showing a loss?

That is the question a member asked me today. His question has to do with why a credit spread is showing a loss when the stock is still above the short strike.  Valid question, and one that I get asked a lot by newbies. Here is the question, the answer, a follow up question, and a basketball example. The question is in blue, and my response is in red.

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Now I need to be educated a bit.  I have a question about the very last trade that you placed on April 28th, where you sold 4 May 1310 puts and bought 4 May 1305 puts.  The SPX was at 1355.77 when you placed the trade so I am assuming (perhaps wrongly) that the goal is for it to stay above 1310 and if so we keep the full credit. exactly

I paper traded this along with you and I am not sure if what my position page of my account is showing is really the story on this trade and I would appreciate your input.  In the gain/loss column next to this trade from day one has shown a negative.  I am trying to figure out if that is correct that we really are in a loss position currently or can we not go by that if we are doing a credit spread where the goal I think is for both the puts we sold and bought to expire worthless so we keep the credit.  you would want it to show a profit. I think it did show a profit in the beginning, but as of right now I am seeing a $40 loss. but that is ok because the option selling prices fluctuate so sometimes these numbers are not exactly “accurate”

If the SPX is still above 1310 I would think we would be in a positive position since that is what needs to happen at expiration in order for us to win or profit on this trade.  I know that time value has to be factored in but still I would think the trade would be positive at this point unless I am missing something.  I am even wondering if perhaps a negative loss position at this point is really a good thing because we want them to expire worthless, or am I overthinking this and if it shows a negative currently then the trade really is working against us currently.  Yes, if it shows a credit loss, the trade is not going in our favor it is going against us.

I did not know if the software with options express is smart enough to take into account the strategy that we are using and therefore the gain/loss they are showing is always correct or do we have to do something different with that information to know where we really stand in the trade at any given time?  If the latter is correct then it would be great to see an article or something that explains what modifications or interpretations we have to make to what is reported on our position page for the different types of trades that you make in order to know where we really are at any given point in time.  Please help, I may just be lost deep in the woods but I am confused and need some assistance. the strategy has nothing to do with it. As days go by the options will lose value and the p/l will change but the p/l is showing you what is happening today, you are talking about expiration so if you exited the trade today, you would lose money since it is showing a negative. does that make sense?

Don’t you just love novices?  Hey man, I am trying and studying like crazy but sometimes it all runs together and gets overwhelming.
It will take some time, but you are getting the hang of it.
Thanks for any help and clarification you can provide.

Here is his follow up question (in blue) and my basketball analogy (in red)

Very helpful Allen, thank you.  So one final question then.  If the goal is for it to stay above 1310 at expiration so we keep the full credit, and it is above that currently, then why is it showing a loss.  I understand that you are saying that if we exited now it would be a loss, but why is that the case if it is already above where it needs to be at expiration.  I am sure the answer to this is the key for me to understand how it all fits together.  It would seem to me that we are above where we need to be at expiration so we are in a “gain” position and all we need to do is remain there?

Maybe an example would work better.

Lakers/Mavericks Game 3.
Mavericks are up 2-0 in the series and they are playing in dallas. (hope you watch basketball and know what i am talking about)

You think dallas will win and you bet $100 on the game.
The odds are 1:1.5 so if you bet $100 and you win you will get $150 back.

Fast forward: It is half time and the lakers are winning by 10 points – if you were the place the bet now you would get 1:1 odds – bet $100 and win $100.

So where do you stand if you want to get out of your bet?

Dallas could still win but you have to wait till the end of the game. But if you want a buddy to take over your bet, then you need to pay him $50 because he is taking on more risk than you did.

Same with our credit spread, if you want to exit now, you have to pay up because the trade/game has not gone in your favor yet.

Best Option Trading Strategy

If on the other hand, SPX had gone up 100 points, our trade would be showing a profit and we could exit with most of it in tact. We would not get the whole credit because of the time value of the options (there is still a small chance SPX might drop all the way).

 

21 Comments

  1. ray on May 5, 2011 at 3:20 pm

    Does that suggest the platform does not correlate the real time options prices with the spread traded if it shows a loss in real time?

    • Genius on May 6, 2011 at 11:08 am

      No, it means that the trade IS losing money and if you exited the trade right then, you would have a loss. It just means that the trade has gone against you so far. It has has time and so you can still make money, but you will have to hold it until the time decay kicks in.

      • Karolyn Son on August 12, 2018 at 8:32 pm

        Thanks for your answer Allen~

  2. keith on May 5, 2011 at 9:19 pm

    my 2 cents and input:
    just because spx is above the 1310 strike doesn’t mean were even. as it goes down, so does our position.
    as the spx is going down, we are losing money(possibly temporarily) just think if you were the one who BOUGHT the 1310 put. as the spx is going down, you are gaining money on your position.
    other angle: if you enter position of put credit spread,and spx plummets in a day to 1311, we are down huge. but if it were to stay there for the entire time, time decay would pull the option down until it becomes worthless on expir day and you would be seeing you position become less “red” and then start becoming “green” until all of the premium is yours on expir day
    IMPORTANT QUESTION for allen
    okay the further out the strike we sell, the safer we are UNLESS the spx goes down to it. the further the distance from the spx to our strike, the more loss we can incur if it goes that far. If the spx and our strike were close, we couldn’t lose as much money becaues the shorter the spx has to fall, the less we can lose (but i understand that the more room you give it, the more chance the spx won’t reach it) the problem is when it does gets close to our far out strike, it’s scary, so is that when adjusting comes in? when and how do we do it so as not to get burned to badly or not at all when the spx were to get too close to our strike?

    • Genius on May 6, 2011 at 11:15 am

      Keith,
      Thanks for the explanation.

      As for your question, adjusting comes with experience. When you get into a trade like this one, record everything – time, prices, days to expiration, the greeks of the options, everything. Then you can build your adjustment rules based on change sin these factors.

      For example, an easy way to adjust with credit spreads is based on p/l. If the trade can make 10%, you will exit when it is down 20%. You dont want to lose more than 2 months worth of work. Or you can base it on the delta of the short option. If you get in when its delta is 15, you might adjust when the delta hits 20, or 25, or 30. You have to balance the adjustment point with how much a loss you are willing to take before you adjust. Letting it go to 30 delta means you will be in a much larger hole when you adjust than if you did it at 20 or 25 delta. But then 20 or 25 might be too soon.

      I take a look at many factors before adjusting, days to expiration, the volatility of the underlying, the momentum and price drection as well as the p/l, greeks, and others. For new people, adjusting on p/l is probably the best way to go. Papertrade, or backtest if you can to find the optimal combination that you are happy with.

  3. DB on May 7, 2011 at 10:45 am

    Does “adjusting” increase the potential loss? And what would be an example of an adjustment? Do you sometimes have to adjust more than once?

    • Genius on May 9, 2011 at 12:50 pm

      DB,

      Adjusting can increase the risk, but it depends on the strategy and the adjustment. You could just take off the trade and re-enter it at different strikes, but that will lock in a loss on the initial spread and unless the credit is enough, you wont have enough premium in the new spread to make back what you lost. That is why sometimes you have to increase the size of the position. Increasing the size will increase the risk and potential loss. Sometimes you do have to adjust more than once, but that does not mean you will increase the position everytime you adjust.

  4. MIKE LOOS on May 8, 2011 at 9:46 am

    Great info for all levels of players.Tks Allen

  5. Billy on May 8, 2011 at 10:52 pm

    Just think of each strategy as a position. It could go up or down. Whether it be condors or credit spreads, it is a position with characteristics or what we software folks call properties. It’s like a long put or call, but with stronger chance of success for defined profit/ loss.

  6. rj fiore on February 6, 2012 at 4:39 pm

    so the key is to find an option with a large premium,by that i mean if a stock is $30 and the call premium is $3 for the 30 strike,then the over premium is $1-(28+3 -30= 1)
    is that correct

    • Genius on February 7, 2012 at 11:48 am

      RJ,
      Not sure what you mean by over premium.

  7. Wayne on July 13, 2012 at 10:13 am

    Perhaps it was sort of mentioned, but the other thing that can occur is change in vega (i.e. implied volatility). Even though the short side is OTM, an increase in vega will increase the prices of the options, and thereby change the profit/loss of the position.

  8. hobert hampton on July 3, 2013 at 8:31 pm

    This is what I was trying to point out before everybody just jumped in like lemmings. This type of trading can go against you very quickly and the losses can be substantial. If you do not understand what is going on in these trades you should not be placing the trades. Sure selling the option puts you on the right side of the trade about 80% of the time and that is a great place to be at the start but you should know about these trades so you can plan ahead to make the appropriate adjustments. Genius had indicated earlier (I believe) that you really did not need to know everything about these trades as long as you have the proper input to make the adjustments but one needs to know everything possible in order to make profitable trades including a strict set of rules th guide you in choosing the right trade to make. You do not have to have a trade every time if there is not one with the right strike and a good risk/reward potential. DO not do a trade to just be in the market. Be very choosy as to the trades you make.

  9. johnip on October 12, 2013 at 9:44 pm

    I have been trading a lot of options (covered calls) with Schwab, and frequently see a loss on my monthly statements long before the options have expired. I think this is because my statement is showing me what would happen if I were to close the position at that time. Thus, with a Bull Put Spread, even if SPY remains above 1310, you would typically lose money if you were to close out the spread before expiration. That is, it would cost more to buy back the 1310 Put than you got by selling (to close) the 1305 Put.
    At least, that is my interpretation of those “loss” values.

    • Genius on October 15, 2013 at 1:41 pm

      Most likely that is what it is.
      Once you sell an option, the value of the option fluctuates. So between the time you sell it and expiration the position could easily show a paper loss. That is probably what you are seeing, because your broker is just listing what the value of the position is at the time of the statement.

  10. sally on December 3, 2014 at 7:32 am

    Lots of paper trading may help but knowing enough to proceed with confidence seems to leave one vulnerable to being Fooled by Randomness. I recommend this book to every trader.

  11. Frank on March 31, 2015 at 9:30 am

    I notice also that some strikes might be traded for a higher price while another strike sits idle which affects the current valuation of the spread. Eventually it evens out again.

  12. Stan py'ski on August 8, 2018 at 1:04 pm

    I am doing a paper trade: Buy Aug. 31 111.50 P & Sell Aug31 116050P @ a Net credit of $1.10 ! It looks to me this is a loosing trade as of now . My question are : Is this a losing trade ? & 2nd is there any way to correct it ? Possible by rolling into the next month ? If so how would I do that ?

  13. TRACEY on November 27, 2019 at 8:25 pm

    Hello,
    I’m new to options trading just started 2 weeks ago. And I started with 4 call credit spreads. I started with $1000 in my account and I’m already down $50. I was wondering if on Friday if all 4 expire worthless and I get my $100 premium, will my total be $1000 plus $100 or $950 plus $100?

    • Allen Sama on December 5, 2019 at 1:29 pm

      Whatever your profit is will be added to your account balance. So if you started with $1,000 and you get $100 in credit, and your options expire, you will have 1000 + 100 – commissions/fess.

  14. Sam Allen (no relation) on October 16, 2020 at 1:44 pm

    I see that you specialize in credit spreads. however Chuck Hughes uses only debit spreads. Is there really a great difference?

    With a credit spread you get paid up front and if the spread is completely successful you get to keep all of it. If your short option does not expire out of the money you must pay some of it back. With a debit spread you pay in advance and if the spread is profitable you get more back. You can make or lose just as much with the one as with the other.

    Informed opinion is that a debit spread is better if implied volatility is expected to rise and a credit spread is better if implied volatility is expected to fall. Both types thrive in an environment of low historical volatility. It is possible to create spreads that have a negative expected value if let run to expiration if historical volatility is too high. I have just worked out a couple of examples and would be glad to send them along.

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