Registered User
Joined: 6/15/2008
Posts: 1,356
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The reason for this thread is to help other beginner option traders, and hopefully get some input from seasoned option traders.
I recently had an "aha" moment when I discovered credit spreads.
I have about 2 years of active trading under my belt, and after blowing up my account twice, I realized I needed to get more experienced in Technical analysis. started with SF, and I like to believe that so far I've gained quite a bit of knowledge and now trade profitable for about a year or so. My strategy is to find stocks that have momentum one way or another and trade calls and puts. Allthough I love the leverage, money management is even more important then with trading stocks.
I have traded them with the misconception of thinking that the most profitable way is to trade 1 strike OTM near month expiration. more times then not, I find myself acquiring a loss due to the delta time erosion of the premium. in other words, the stock did not move enough prior to expiration.
Credit spreads are designed to limit loss, with a limit profit potential. At first sight this doesn't sound appealling, I want "maximum" profit. However, given the above mentioned misconception and carefull planning of a credit spread trade, it might just increase your ROI.
To proof this thinking I'm going to take on simulated trades, and compare ROI's between buying the stock, buying a call, and buying a credit spread.
A Bull call spread is constructed by buying a call at one strike, while selling a call at a higher strike price with the same expiration. You receive credit fom the sale of the higher strike call, and you take a debit on the purchase of the lower strike call, hence lowering your cost compared to buying a single call.
This morning I bought (papertrade) a ORCL January 29/32 call spread. the 29 call was $1.31. and the 32 call was $0.22. therefore my cost was 1.31 - 0.22 = $1.09 per contract.
my max loss, if ORCL is below $29 at expiration is now limited to $1.09, and my max profit if ORCL is above $32 at expiration is limited to 32-29 - 1.09 = $1.91
My expectation is that ORCL will trade around $32 before January 21st expiration.
Based on these numbers I want to compare purchasing ORCL shares versus a call, and a bull call spread.
Below is a spreadsheet comparing the 3 trades. I will update it once a week until expiration.
as you might now, one call option controls a 100 shares of the underlying stock.
I bought 10 contracts, therefore we have to compare this to a trade of 1000 shares of ORCL.
Below is a risk graph of this trade.
By looking at the graph it probably is better to not wait untill expiration, but more at the time when the graph starts to flatten out.
My question to the more experienced option traders is:
where can i find a tool that searches for credit spreads and can sort by ROI, and probablity.
I know Optionetics has a tool, but they charge an arm and a leg.
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Registered User
Joined: 2/1/2010
Posts: 37
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Why not writing options vs. buying them? If you're bullish on ORCL, then why not shorting ORCL puts, and pocket the proceeds. Let time decay work for you instaed of against you. You can (should) short a put spread to limit risk. Worst case is that you end up having to buy ORCL if the option was excercized against you.
Just my 2 cents.
good luck.
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Registered User
Joined: 6/15/2008
Posts: 1,356
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So far, I have traded only long calls, and long puts, not any of the advanced strategies, spreads, strangles, calendars, condors, and what have you.
At first it seems overwhelming all the combinations you can come up with. I'm more of a hands-on person, so I think by actually trying them all out, I can hopefully get my arms around it.
back to the subject at hand, it seems to me, looking at risk-graphs, that the short put and the short put spread have a higher max loss, and a lower max profit, compared to the long call, and long call spread.
I should add the short put trades to my spreadsheet and add them in the comparison.
oh and my goal is to only trade the options, I never want to end up getting exercised with the stock.
thx 4 ur 2cents. 
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Registered User
Joined: 6/15/2008
Posts: 1,356
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great prezo on this subject:
accordent.powerstream.net/008/00124/presentations/TK20080428/f.htm
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Registered User
Joined: 10/9/2010
Posts: 18
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I've been using options for the past few months... buying calls in the money, often deep ITM. While the cost is higher, it does provide good leverage while also bringing the time premium down (compared to ATM or OTM).I've also been testing call spreads, but I'm a little cautious of the technique since you loose flexibility on your exit -- if the long call is profitable but the equity's technicals weaken, you have to either close the spread with limited gain (buying back the short) or letting it ride to expiration, hoping it doesn't weaken further. Maybe there's some aspect or method here I'm missing, but the only solutions I've seen are related to converting option strategies.
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Registered User
Joined: 6/15/2008
Posts: 1,356
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Can't argue with that ih.
everything is a trade off. what appeals to me with the bull call spread is the reduced risk. If you choose a spread carefully, the risk/reward is much better then the, (close to 1Delta), ITM calls.
You can argue that you can set a stop on your ITM calls, to reduce your risk. However most of the losses occur overnight. BBY today is the perfect example. 36 calls dropped from about $6.00 to $0.30. A stop loss would not have saved you. with the spread I know upfront what the max loss is.
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Registered User
Joined: 7/1/2008
Posts: 889
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Did you read the Demark option book?
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Registered User
Joined: 10/9/2010
Posts: 18
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I wouldn't argue for setting stops on ITM calls... I've tried that and seen the same as you -- that many times the move is overnight. Even a sudden day move may not fill anywhere near the stop price, probably since the volume is low.
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Registered User
Joined: 6/15/2008
Posts: 1,356
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Yes ben2k9, that's why I repeatedly ask for option data chain in SF. would like to run indicators directly on option data charts. demark has a couple indicators specially for option data.
by the way did you read my request for you in the demark thread?
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Registered User
Joined: 6/15/2008
Posts: 1,356
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One week later:
103% profit on the spread versus 132% on the call, and just 8% on the shares.
wish I had made this trade instead of papertrade;
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Registered User
Joined: 6/15/2008
Posts: 1,356
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that wasn't the closing price today, but rather the highs.
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Registered User
Joined: 2/8/2005
Posts: 81
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For the long call, the max. profit at the targer $32 on expiration day should be $3000 - $1310 = $1690. You may see higher profit when the price reaches $32 earlier due to the time premium. Long call has lower reward-to-risk ratio than corresponding call spread but it moves faster when the direction is right and the profit is not capped as the spread. Also, I like the simplicity of long call (for my simple and stupid mind).
Spread is good when the long call premium is too high and spread can help to keep it more manageable.
Happy trading!
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Registered User
Joined: 6/15/2008
Posts: 1,356
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Yes Billion, thx for pointing that out.
As I've mentioned before there are tools available that will calculate and sort out spreads for you with the highest profit potential. Thinkorswim has a "spread hacker", but I haven't been able to make heads or tails out of it yet.
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Registered User
Joined: 6/15/2008
Posts: 1,356
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Interestingly the call spread hast started to outperform the long call as of Dec28. Orcl set a high on 12/17 at $32.27 and since then has drifted lower to low $31.
Sideways movement towards experiation date is in favor for the spread, time decay at work.
Still the biggest profit was set by the long call. with the quick rise in price up to Dec/17.
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