When you write about the idea of ”reversal”, it refers to the strategy of closing your current position and moving (i.e., moving) to a longer expiration date. The strategy is based on the erroneous idea that if you have given the position more time to work, your current situation (where you are losing money in trade) may be reversed.
This idea is very simple and, as described below, many marketers get serious problems
Yes, something had to be done earlier. The bottom line is that every trader needs to know when the risk of owning a particular position has increased beyond the comfort zone of the trader. My comfort zone requires adjusting credit spreads before the short option moves beyond the strike price . The boundaries of your comfort zone probably vary. It is important that you have a risk management plan that prevents account killing, a huge loss .
Some seasoned merchants adopt a policy of adjusting credit spreads when the premium is doubled. From my perspective, it’s a bad plan. Such a rigid rule is generally inappropriate. For example, if you collect 50% of the maximum possible premium (i.e. $ 5 for a 10-point spread), then your adjustment point will never be reached because the spread premium never doubles to the theoretical maximum of $ 10 before it expires expiration.
Additionally, if your strategy is to raise a small premium (i.e., $ 0.15), the likelihood of being excluded from the trade is nearly 100%.
Instead of such a rule, I suggest that any expansion be considered on its own merits as it is not practical to try to fix all the stores. Nor is it reasonable to adopt an identical repair strategy in every store.
Sometimes giving up a trade and accepting the fact that it has lost money is the best possible risk management decision. On other occasions, it makes sense to improve the position.
The decision on when to adjust positions should be based
- Your personal risk tolerance and the limits of your comfort zone.
- The current risk (the amount you can lose) is about holding a position and the maximum possible loss you can afford – without violating your account.
If you were using “double the premium” as a trigger to repair the credit spread, I would have no objection, as long as the original credit schedule met certain criteria. For example, a premium doubling plan is appropriate when
- The 10-point index credit spread spread collected is $ 1.00 to $ 1.50.
- At least two weeks remaining before the options expire. When less time is left, repair strategies are tougher to handle because the positions have significant negative gamut.
- Positioning leaves you with the new position you want in your portfolio . One of the problems with position repair is that some traders believe that repair is necessary, regardless of the situation. Consider repair ONLY when you are very comfortable with your newly rolled position. Returning to a risky position makes no sense as there is a high chance of another loss occurring (the original store has already lost money).
These parameters are not set in stone. In fact, it may not work for you. But the important thing is to understand that a premium doubling plan is inappropriate in many situations.
For example. Let’s say you like the idea (I don’t) of selling very further OTM credit sales and collecting a small premium ($ 0.25 or less for a 10-point spread). Of course, this trade has a very good chance of being profitable. However, the profit potential is low and I don’t like the high probability that the premium will double – which forces you to lock in the loss. When you adopt a strategy of exiting (or adjusting) premium doubling, then selling a small premium credit spread is simply not sustainable.
First, most of the time the market moves enough to expand from $ 0.25 to $ 0.50. This means repairing a store that stays well in your comfort zone.
Nobody likes it. Second, if implied volatility is implied, the greatest impact on further OTM options is. This means that the spread you sold @ $ 0.15 could easily trade for $ 0.30 – requiring you to exit – even with the price index unchanged. Would you really adjust to the circumstances? I would not.
Third, the markets for offering / seeking options are quite wide. Let’s say you’re selling the width for $ 0.20. It is very reasonable to assume that when you placed your order and filled in the $ 0.20 amount, the spread bid price was ~ $ 0.15 and the asking price was ~ $ 0.35 or $ 0.40.
How would you decide the premium has doubled and it’s time to adjust?
Would you use the asking price? You can’t do that, because it would be time to adjust as soon as you did the trade. So that is clearly out of the question.
Would you wait until the offer was $ 0.40? If you do, you have almost no chance of paying just $ 0.40 to get out. Would you wait and hope to get an order to pay $ 0.40 or do you want to go out (i.e. a good risk manager doesn’t hesitate to do the right thing – which is to reduce risk) and pay as much as $ 0.60 to exit? If the bid is $ 0.40, the exit cost will be higher. This plan is also not sustainable.
Fourth, why all these stores cost money. Not just commissions but skating. When we sell a premium and hopefully earn from a time crunch, it is better to trade as infrequently as it is smart. Never avoid trading when it is time to manage risk – but this premium repair plan doubles the premium with low credit spread rates.
If you agree that selling a cheap premium does not work for you, then how do you sell loans that are not far from OTM? If you raise $ 4 for a 10-point spread, then your plan will require no adjustment until the spread reaches $ 8. By then the options would be pretty far from BMI and there is nothing (good) that can be done to improve the position. A trade decision would be reduced to two choices: go out and take a loss or hold on and hope for the best. Not an attractive choice either.
For these reasons, the strategy of adjusting the premium doubling must be limited to certain types of credit spread. So if you adopt that plan and use it reasonably, it may work for you. But this plan comes without my recommendation.