New to Options trading - Appreciate your help

[omad]

i would also (and this is just personal opinion, others may disagree) suggest starting out with DEBIT spreads rather than credit spreads. debit spreads i think are safer for newcomers (compared to credit spreads) because the max risk of the position is paid in its entirety up front, so you're less likely to get into trouble with collateral etc.

getting a feel for your risk in credit spreads will become second nature after a short while, but when first starting out, it is quite possible to get it wrong and wind up overextending your trading account.

in my opinion the main focus when first starting out in options should not to be to make the max profit possible, but rather, it should be to make sure you don't blow up your entire trading account during the learning process. something that is very easy to do with leveraged derivatives if you're not careful, especially with IB where there is no level 1, level 2, level 3 etc. permissions, like there are with some aust brokers, that function to restrict the types of strategies you can do. in contrast, as soon as your IB account has options trading approval, they give you all the toys to play with. yes, they will let you sell a naked call (if for some unfathomable reason you actually wanted to do that) provided it meets the initial margin. i know this for a fact, as when i was first starting out in options, i crazily tried to leg into a call spread by going for a fill on the short leg first, as i thought the underlying was about to "ease off a bit" and i could get the long leg filled more cheaply. so i essentially had a naked call for several very uncomfortable minutes as i watched the thing keep rallying. never again. free tip - DON'T DO THAT!

so yes you get all the toys straight away at IB but it's a double edged sword because as soon as you fail to meet your margin requirements - and they calculate that in real time, not just on an end-of-day basis - as sails said, you're given a few minutes notice before they start closing down positions randomly. so you must be careful and IMHO sticking to debit spreads, at least at first, is one way to do that.

For the sake of the discussion I'll partially disagree, I think starting out with defined risk trades is a good idea for beginners but I don't think debit spreads are better then credit spreads.

Credit spreads are defined risk just like debit spreads so once entered your margin requirements don't change, even if the underlying goes through your strikes, so no need to worry about margin calls, your max loss is the width of the strikes less the credit received and this is all your broker will hold as margin. If your using correct position size then you won't blow up your account.

I would prefer to trade credit spreads over debit spreads due to the higher probability of success but when volatility is low debit spreads are the way to go. This is what beginners should be focused on, when to use which strategy.

As for naked calls (and puts), if your happy to short (or buy) stock then there's no reason not to sell naked calls (or puts), again as long as you're using correct position size you are controlling your risk, most people get into trouble by trading too big. Margin requirements will change with naked options as the underlying moves so they definitely need more managing then spreads, once open I don't touch spreads other then to close for profit, if it goes against me I'll let it go. Every month I have spreads go to max loss. If you're getting margin calls/positions closed I would say you're trading to big.

 

[Newtotrading]

IBs margin rules take care of that though. Also, (presuming we are talking OTM credit spreads) IME the bid/ask spreads are usually higher in the equivalent debit spread.

Synthetically equivalent yes, but higher contest risk.

Thanks everyone, I am certainly taking it all in. I have just started to papertrade with Optionsxpress doing OTM credit spreads with a stop loss on RUT. I will be cautious with IB and make sure I know risks etc when I trade with them. I will definitely learn debit spreads, I am just trying to learn one thing at a time and understand it completely. Thanks again. Anne-Maree

 

[Sharkman]

very good points. but to be fair, i'm not arguing that debit spreads are better than credit spreads, or vice versa. as you said, there are situations to do debit spreads and there are situations to do credit spreads. but i do think debit spreads are a safer strategy when one is first starting out trading options for the reasons i mentioned.

personally i never do naked calls. sure most of the time you won't get burned, but what if you were short naked calls on rio tinto, back in 2007 i think it was? that could have blown you out of the water right there. position sizing can help, but i prefer to just protect the upside risk by buying OTM calls. helps me sleep at night. plus i find most of the time the delta skew just begs me to do it anyway, with typically dirt cheap IV at the higher strikes. to each his own though.

 

[wayneL]

I would prefer to trade credit spreads over debit spreads due to the higher probability of success but when volatility is low debit spreads are the way to go. This is what beginners should be focused on, when to use which strategy.

Agree with the rest of your post, but when comparing credit spreads to debit spreads we are both making assumptions that need clarification.

I don't know whether that is what he meant, but in my assumption Sharkmans suggestion is using the equivalent debit spread, ie same strikes and expiry.

In your assumption a credit spread is constructed OTM (eg say a put spread with a OTM short put and further OTM long put) and a debit spread ATM (eg say a call spread with slightly ITM long call and slightly OTM short call). There are good reasons why this is generally the way things are done for the given profiles, but for NTT's edification this needs to be made clear.

IOWs OTM credits spreads and ATM debit spreads are two different beasts that should not be compared in the same situation. An OTM credit spread is almost purely a premium collection strategy (notwithstanding other considerations) whereas an ATM debit spread is a directional play.

 

[omad]

WayneL, You're right, I was comparing OTM credit spreads to ATM debit spreads as that's what I trade. If Sharkman is comparing same strikes then no difference in probability of success. My point was debit spreads are no "safer" then credit spreads, your loss is still the same if the trade goes against you. If he was referring to the beginner trader being able to understand their position easier then sure, I can see this.

Sharkman, short calls in RIO would have hurt for sure, if your position was small enough it could have been managed. Stock jumped $30 then a couple of months later was down $36. I find naked positions easier to manage then spreads, if I'm wrong with spreads I very rarely make adjustments but I'm very aggressive with adjustments in naked positions.

In saying that at the moment due to low Vol I have very few naked positions on, can't wait to get some Volatility back in the market.

 

[Sharkman]

If he was referring to the beginner trader being able to understand their position easier then sure, I can see this.

yep that is the point i was trying to make. sorry if this was unclear. i wasn't advocating trading the synthetically equivalent debit spread if Anne-Maree finds a good opportunity to use a credit spread, but rather, to try and identify opportunities conducive to the use of debit spreads, and trade those instead. at least at first.

you guys have probably (definitely in wayne's case) been trading options for longer than me so you might have forgotten what it was like when first starting out. a newcomer could mistakenly assume, i have one bought and and one sold leg of equal size, therefore the former is hedging the latter, ok sweet i can use the remainder of my account to put on new positions - only to misjudge the max risk of the credit spread, then get margin called when they do put on new trades and the market moves against both. i think IB use reg-T margin calcs for ASX options, even if your account is portfolio margin, so the entire distance between the strikes has to be stumped up as collateral. don't know for sure though as i do everything fully cash covered for the moment.

 

[omad]

I don't trade ASX so not sure how IB handle margin on spreads, it's probably on their site somewhere.