When Do I Buy Back A Credit Spread?

Credit spread inquiry: 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.

Option trading analysis

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.

Apple credit spread

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.

11 Comments

  1. Bob paulish on October 20, 2009 at 2:00 pm

    What broker do you use that charges $2.50 in commissions?

  2. steven thomas on October 20, 2009 at 7:24 pm

    Interactive Brokers is only about $.70. i got ThinkorSwim to give me 1.25 per contract flat rate today

  3. Jeff on October 20, 2009 at 10:54 pm

    I don’t remember this recommendation. Was this one not published?

  4. Genius on October 21, 2009 at 10:03 am

    Jeff,

    This was a little higher risk trade and was not part of the OptionGenius portfolio. I did it in my personal trading account. We have done AAPL credit spreads in the OptionGenius portfolio before but since I take a very conservative appraoch I did not want to expose members to the risk – which was earnings. AAPL had a good quarter and the price shot up. It could just as easily had a bad or so-so quarter and had the stock price fall by the same amount, in which case the trade would have been a nail bitter.

    OG

  5. Bruce Dennis on October 22, 2009 at 8:37 pm

    I have been using Think or Swim for about 2 years now and have been very happy with them.
    They have good commisions, especially for smaller accouts this can be huge. Also, their support is top notch. If you email them a question or live chat, you could even get an answer from the CEO of TOS. Highly recommend them. Take them for a test drive for free!

    Bruce

  6. Xueren Zhang on October 26, 2009 at 5:24 pm

    OG.When you are talking $2.5 per spread,you mean no matter how many contracts per spread you trade ? For example,if you sell to open 20 contracts of apvwq and to buy to open 20 contracts of apvwp,your broker only charge you a total of $ 2.50 ?

    If so,how can we negotiate such an unbelievable commission ( if we trade ten options a month ) as individuals,not institutions ? Even Optionhouse or Thinkorswim can’t let us have $2.5 per spread ? Optionhouse charges $14.95 per spread,and Thankorswim charges between $1.00 to $2.20 per contract ?

    If we can’t have rock bottom option commissions,it’ hard to follow and execute your trades as a member,because you have adjusted your trades quite a bit? It’s OK for you because you just pay $2.5 each time you trade ( unlimited contracts),but for your members,if we pay $10 to $22 ( 4 to 20 contracts per spread ),your members are are really at disadventage positions,and will never achieve such ROI per month and per year as you do in your newsletter ?

  7. Genius on October 27, 2009 at 6:04 pm

    My commission is $1.25 per option. Not $2.50 for unlimited options.

    Actually commissions do play a role but not as much as you make it seem. And not on most trades.

    For example, the MCD butterfly i did last month. This trade bought and sold 63 options. (Because of the adjustments). You might remember this trade Xueren, you were talking about it in another post.

    And it had a pre commission profit of $141. If you paid $1.50 per option, you paid $94.5 in commissions. That’s a lot. But you still made $46.50 or 2%.

    This is the highest number of options I have used in any trade I could find.

    So even in the most commission intensive trade I have done in a while, I sill made money.

    Most of our trades use much fewer number of contracts. That’s why I use SPX instead of SPY and RUT instead of IWM.

  8. Genius on October 27, 2009 at 6:08 pm

    Oh and all my calculations are using a regular margin or Reg-T account. If you have a portfolio margin account your returns will be so much higher that commissions will be the last thing on your mind.

  9. Tom Plaskett on October 5, 2010 at 7:22 pm

    Of course, we are dealing with information that is a year old in this discussion. Things have changed a lot since then. Commissions have gotten more competitive and brokerage houses have also gotten more conservation so they don’t do anything wrong. You have to take a little bit of the good with a little bit of the bad. I think it comes out in the wash as long as you compare each of the sites as apples to apples and not apples to oranges. Thx. Tom

  10. belinda on July 21, 2011 at 7:36 pm

    good evening allen,

    one of your recommendation is think or swim broker but they charge 9.99 canadian dollars + 1.25 per contract…and here is one of your comment above that contradict your recommendation…(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.)
    I am confused please clarify…thank you so much

    • Genius on July 22, 2011 at 9:07 am

      Belinda,

      You want to get a good broker with commissions as low as possible. For Canadians the commissions ratea are different. I do not know why – never really looked into it. But you guys pay a lot more.

      So what can you do?

      One option is to try to negotiate with the brokers. The larger your account size, the lower they are willing to go. And tell them you are considering them and 2 others. The rate that is listed on their site is not the bottom line price.

      Another option is to check with other brokers. Interactive Brokers is in Canada and they are pretty cheap here in the US. Their platform takes a while to get used to but many professionals use them so they are good.

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