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.
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.
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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).