Defensive Measures

[costaprovataris]

Hi All

I have been trading options (credit spreads) for a little while now and would like opinions on the best defensive measures if the trade goes against us and when to activate these defensive measure...

As an example a trade I took a few weeks back when ANZ was trading around $21.50...I sold 20 x $21.50 Jan Puts and bought 20 x $21.00 Jan Puts...If ANZ had in fact fallen rather than headed north when is the best time to take defensive action and what type of defensive measure (i.e. Close out current spread and re-do lower down? Roll down? Roll out?) Much appreciated....

 

[Fox]

...when is the best time to take defensive action

One approach is to take action when your personal risk threshold is reached. If your risk threshold is low, you might choose to take defensive action early.

Another approach would be to take action early enough to salvage your position. If you take action when your losses are already too heavy, then it would be difficult to eventually exit your position with a profit.

what type of defensive measure (i.e. Close out current spread and re-do lower down? Roll down? Roll out?)

The good news is that there is a myriad defensive measures. The bad news is that applying them effectively will depend on the current and future market conditions. Ask a pilot about defensive measures in averting a plane crash, and he will probably check is altitude, speed, wind speed and direction, weight, fuel level, etc, before deciding.

Both flying and options trading require understanding the physics of your vehicle. That can only come from experience, effort and study. I am currently doing all three and not finding it easy at all.

 

[costaprovataris]

Thanks Fox, it certainly is a learning curve and practice makes perfect...What I have learnt is that we are to roll or create an oppsoing credit spread it must be done early certainly 2-3 weeks out whilst the oppies stiull have some sembalnce of value...trying to roll down/up in the last week is a certain death on that trade most times anyway...Agian thanks for your thoughts much appreciated....

Hi All

I have been trading options (credit spreads) for a little while now and would like opinions on the best defensive measures if the trade goes against us and when to activate these defensive measure...

As an example a trade I took a few weeks back when ANZ was trading around $21.50...I sold 20 x $21.50 Jan Puts and bought 20 x $21.00 Jan Puts...If ANZ had in fact fallen rather than headed north when is the best time to take defensive action and what type of defensive measure (i.e. Close out current spread and re-do lower down? Roll down? Roll out?) Much appreciated....

 

[wayneL]

I hate defending credit spreads. I think they are a pig of a thing to defend, unless as one half of a condor where I can manage delta neutrality effectively.

What you have to understand is that you are playing a statistical game with credit spreads. You have to think like an insurance actuary.

I haven't trades a credit spread since April. Although they would have been easily profitable, the actual odds didn't stack up well enough for me, and it keeps getting worse as volatility declines.

Doesn't mean they won't profit, but it means that the odds are not in my favour, and I only take on that sort of risk/reward scenario when the odds are well stacked on my side.

Defence costs money and the profit margin is already skinny with CS's.

Just something to think about.

 

[costaprovataris]

Thanks Wayne, your insight is much appreciated..can you let me know your thoughts on the folloiwng:

When I believe a stock has run hard and will turn lower over the next 4-8 weeks I tend to do the folloiwng about 5-6 weeks out:

B 25 x OTM (say ANZ Calls @ $23.50)
S20 x ATM (say ANZ Calls @ $23.00)

The reason I buy the extra 5 is for comfort in the first 2-4 weeks of the trade if I get it totally wrong then the extra 5 will help close out the trade at a small debit or even a small credit (as happened with WES on Monday)...My risk/reward ratio is not great because I am buying the extra 5 of the $23.50 series...This alos helps with IM and keeps it low throughout the term of the trade as we are nett long 5 contracts....

However if the stock meanders around in a narrow range and continues to trade around that $23.00 level as time unfolds we need to do something...my preferred method is to do the folloiwng:

Buy back 25 x $23.00 Calls
Sell 45 x $23.50 Calls
Buy 20 x $24.00 Calls

That leaves me:

B 5 x $23.00
S 20 x $23.50
B 20 x $24.00

Here I have 5 long protecting the 20 short with a strike as some comfort...This roll costs and may result in an overall debit but can also help repair the trade....

Any thought on this much apprecitaed.....any any other ideas is also much apprecitaed...

I hate defending credit spreads. I think they are a pig of a thing to defend, unless as one half of a condor where I can manage delta neutrality effectively.

What you have to understand is that you are playing a statistical game with credit spreads. You have to think like an insurance actuary.

I haven't trades a credit spread since April. Although they would have been easily profitable, the actual odds didn't stack up well enough for me, and it keeps getting worse as volatility declines.

Doesn't mean they won't profit, but it means that the odds are not in my favour, and I only take on that sort of risk/reward scenario when the odds are well stacked on my side.

Defence costs money and the profit margin is already skinny with CS's.

Just something to think about.

 

[wayneL]

While the market continues to trend broadly upwards, you will get away with such adjustments.

A nasty bear will disembowel you however with both delta and vega.

What I'm trying to get across is that the strikes and ajustments are unimportant, it is the odds/stats that are important.

No matter what you do, you just have to receive more nett premium than is warranted by the statistical risk. If it's the other way 'round, you most likely will eventually lose.

There are hundreds of corpses of credit spread traders as a result of the recent bear, because they didn't understand this.

 

[costaprovataris]

Thanks Wayne your insights are much appreciated...

While the market continues to trend broadly upwards, you will get away with such adjustments.

A nasty bear will disembowel you however with both delta and vega.

What I'm trying to get across is that the strikes and ajustments are unimportant, it is the odds/stats that are important.

No matter what you do, you just have to receive more nett premium than is warranted by the statistical risk. If it's the other way 'round, you most likely will eventually lose.

There are hundreds of corpses of credit spread traders as a result of the recent bear, because they didn't understand this.

 

[costaprovataris]

Wayne

Sorry to trouble you again and I hope you dont mind me asking questions, they may sound sill at times, but how do you determine the odds/stats before you enter a trade? do you have a formula you run or equation?

While the market continues to trend broadly upwards, you will get away with such adjustments.

A nasty bear will disembowel you however with both delta and vega.

What I'm trying to get across is that the strikes and ajustments are unimportant, it is the odds/stats that are important.

No matter what you do, you just have to receive more nett premium than is warranted by the statistical risk. If it's the other way 'round, you most likely will eventually lose.

There are hundreds of corpses of credit spread traders as a result of the recent bear, because they didn't understand this.

 

[wayneL]

Wayne

Sorry to trouble you again and I hope you dont mind me asking questions, they may sound sill at times, but how do you determine the odds/stats before you enter a trade? do you have a formula you run or equation?

The straight statistical approach is to use either stat vol or implied vol (or a reasonable projection of your own) to determine the probabilities of your position expiring in the money.

Next step is to determine the premium received versus risk to see if the straight out risk/reward is worth it.

So if you determine that you have a statistical 70% chance of success, the premium received from the spread must be greater than 30% of the spread.

In addition, other analysis can be added to see whether the 70% probability is valid, or whether there is some increased probability based on statistics.

If so, you have a trade that stacks up. If not, better to stand aside.

That's how I do it.

 

[costaprovataris]

Wayne, your a star, very nice of you too help out as much as you do...I do have another question for you, it may sound dumb...In response to the statistical approach you use stat vol or implied vol to determine probablities of position expiring ITM, is their a program out their that projects this using IV? I use Bourse for real time oppies data do you know if this has that capability? Again thanks a million!!!

The straight statistical approach is to use either stat vol or implied vol (or a reasonable projection of your own) to determine the probabilities of your position expiring in the money.

Next step is to determine the premium received versus risk to see if the straight out risk/reward is worth it.

So if you determine that you have a statistical 70% chance of success, the premium received from the spread must be greater than 30% of the spread.

In addition, other analysis can be added to see whether the 70% probability is valid, or whether there is some increased probability based on statistics.

If so, you have a trade that stacks up. If not, better to stand aside.

That's how I do it.

 

[wayneL]

I use my own custom formula in Amibroker.

Maybe I'll post up a way of doing it later on.

 

[costaprovataris]

Thanks Wayne much appreciated once again...I may have to hassle my broker to see if they have a similar tool...If you do post something up later that is also appreciated...

I use my own custom formula in Amibroker.

Maybe I'll post up a way of doing it later on.

 

[mazzatelli]

They are designed to be outright bets - not to be hedged around.
If you insist on the strategy, you can sell shares into the short strike at an increasing rate

 

[cutz]

As an example a trade I took a few weeks back when ANZ was trading around $21.50...I sold 20 x $21.50 Jan Puts and bought 20 x $21.00 Jan Puts

G'Day costa,

I'm not knocking you and I haven't checked prices but why have you chosen to go min strike between the two contracts as opposed to half the size but further apart ?

 

[costaprovataris]

Hi Cutz

The only reason is because If I need to roll down due to sold strike being threatened then I can buy back the 20 x $21.50, sell 40 x $21.00 and buy 20 x $20.50, thus rolling down a strike....What is your opinion on this? I take no offense I am here to learn would you rather sell 10 x $21.50 and buy 10 x $20.50, thus strikes $1 apart? If so can you enlighten me as to why you think this is better, I am happy to listen to all opinions and in fact welcome it...Thanks in advance Cutz...

G'Day costa,

I'm not knocking you and I haven't checked prices but why have you chosen to go min strike between the two contracts as opposed to half the size but further apart ?

 

[cutz]

Hi costa,

I don't really do straight out credit spreads as such but from my point of view strikes so close together wouldn't have enough positive theta for my liking, pretty much all or nothing.

And as mazza pointed out more of a directional play, I'm not really suited to that type of style but I see what you're getting at with rolling.

 

[costaprovataris]

Thanks Cutz

A quick question for you, if I was to sell 10 x $21.00 and buy $20.00, thus a $1 strike differential and the sold strike was threatened what type of defense is best or practical?

Hi costa,

I don't really do straight out credit spreads as such but from my point of view strikes so close together wouldn't have enough positive theta for my liking, pretty much all or nothing.

And as mazza pointed out more of a directional play, I'm not really suited to that type of style but I see what you're getting at with rolling.

 

[costaprovataris]

Thanks Mazza

Is their a strategy that you prefer to credit spreads? if so can you please let me know what it is and maybe some defensive meausres you take if sold strike thretened? Thanks in advance...

They are designed to be outright bets - not to be hedged around.
If you insist on the strategy, you can sell shares into the short strike at an increasing rate

 

[cutz]

Thanks Cutz

A quick question for you, if I was to sell 10 x $21.00 and buy $20.00, thus a $1 strike differential and the sold strike was threatened what type of defense is best or practical?

Hi Costa,

Start shorting some ANZ, good luck if you can do it on the oz market. If your short strikes are threatened on a bull put spread it means that your original directional view was wrong and rather than fight the trend delta hedge or exit the trade.

Personally I prefer to deal with european style options on bigger positions and have some back month long gamma on (in the first place).

 

[costaprovataris]

Thanks Cutz

Your insights are much welcomed....Sorry to be a pain but can you please explain what you mean by delta hedge if my short strikes are threatened? If I sold 10 x $21.00 ANZ Jan Puts and bought 10 x $20.00 ANZ Jan Puts and the $21.00 series was threatened what would a delta hedge be in this case...

What is meant by some back month long Gamma in a practical sense? Can you please explain with a practical example...Thanks very much for your time and effort in assisting me....

Hi Costa,

Start shorting some ANZ, good luck if you can do it on the oz market. If your short strikes are threatened on a bull put spread it means that your original directional view was wrong and rather than fight the trend delta hedge or exit the trade.

Personally I prefer to deal with european style options on bigger positions and have some back month long gamma on (in the first place).