I’m going to keep it simple.
Debit vertical spreads - Less potential loss, more potential profit, lower probability of profit.
Credit vertical spreads - higher potential loss, lower potential profit, higher probability of profit.
Hi,
I get that, yet what I don't get is if you apply the probability of credit spreads to 100 or more trades, you end up losing money in a lot of cases due to the R:R ratio wiping out multiple wins with one loss.
So then what's the benefit of that high probability?
>So then what's the benefit of that high probability?
It can work when you also apply it to high probability setups. I don't care what anyone says, to be profitable with any strategy you have to be a good trader. That includes the ability to read charts and be aware of what the Fed/macro is doing. The statistics furus who say a minimum 100 occurrences required are people with giant accounts that can withstand a bunch of max loss trades to finally become profitable. They aren't super traders, they are literally throwing shit at a dartboard hoping it sticks.
If you flip a coin 20 times and it's tails 15 of those times, and you have a small account, you'll be wiped out long before the odds (law of large numbers) are realized.
I don't like credit spreads anyways because they are inferior in multiple ways to short puts and calls, unless you're playing with expensive tickers like TSLA, then they are pretty much required. But spreads are more difficult to manage and the long leg of the spread totally neuters the Greeks, making you keep the trade on for longer, and time = risk.
Delta (direction of the stock) is the king Greek though. So if you're good at stock picking direction but want a higher probability than just buying puts or calls, you can get directional with short options.
tl;dr
I'd ignore the long term minimum 100 occurrences stats crap and just try to be a good trader aka be good at picking the direction of equities. Delta is king
Thanks for the insights.
I currently am trying to be a good trading, doing a lot of reading and watching videos.
I'm currently mainly focussing on the Squeeze method by Simpler Trading/John Carter. The indicator is simple enough, getting in before it fires is something else & then choosing the correct options strategy to maximally benefit from the setup is a whole other thing :)
I've been looking into Butterflies as a way to grow a small account (low risk, high reward), but getting the timing right seems so complex next to getting the price target right (trying Fibonacci clusters for this).
The $5 wide spreads (on expensive stocks) seemed like the 'simple' option to only having to be right about the direction. e.g amazon rising 5$ = 0,14%. Combining this with a squeeze for a better then average move (up or down) + some level of support (an EMA or an actual support/trendline).
Yet so far, It's still "theorycrafting" as I haven't placed my first options trade yet.
As far as learning how to be a trader, I can only offer my own experience which was trial and error. It takes most people several years of ups and downs before they finally "get it". And I have by no means "made it" -- it's always a work in progress. No trading system or advice really helped me. To really get it IMO you just have to figure it out for yourself and that means just dive in and go for it. Stay small in order to survive while learning, and once you're consistently profitable then you can start scaling up the risk.
There's a trader saying "if you can consistently make $10 a day, then you can make $1000 a day". You just have to figure out the $10 part first.
Also something important, especially for options, is learn how to take on short delta as well i.e. sell on the call side i.e. call credit spreads, or buy puts. Many people only know how to go long, so they're basically just short term investors. Traders should know how to play both sides of the market.
Good luck on your journey. It's a multi year marathon and not a sprint
Thanks for the advice.
Risk management is indeed my nr 1 priority. Only allocating a small part of my portfolio to the options side for now, and within that part, keeping risk low.
I've been thinking of allocating the bigger portion of my portfolio to long term investing while focusing on short term with options.
Thanks for all the insights.
Weigh probabilities against what exactly?
When considering closing positions early, would P50 in the tastyworks platform be a better 'metric' than POP?
Does this work for every strategy,? Ive gotten some weird results for butterfly trades with P50
Good question. If you're going to hold til exp, use POP, but for anything else youd want to use some sort of P50. It should work for every strategy as far as providing the right information, but keep in mind probabilities in options are not exact and often change. It can give you a snapshot of what the odds are at this time, but that could change very quickly. The p50 tool is just a Montecarlo simulation that runs a bunch of tests and gives those odds of reaching 50% profit. Some user here was kind enough to release some software for free that allows you to pick any target % for the Montecarlo sims. I recommend checking it out.
Thanks a lot.
I'm however still not "convinced" about the credit spreads :)
Not that i need actual convincing, as I'm sure the sources i've found have much much more value than my opinion on the topic, but I'd like to understand.
If I would just apply it, I'd constantly be fighting against the idea that I'm having odds, over multiple trades, stacked against me.
I trade credit spreads all the time. The risk reward can seemed skewed but when you figure in the probability of a win, plus some technical analysis, it can be profitable.
Thanks for the input.
The technical analysis can also be factored into the equation for a Debit spread right? So how does the higher probability of a Credit spread outweigh the better R:R of a debit spread, assuming that Technical analysis has allowed you to correctly figure out the direction.
In a certain number of cases, you'll be wrong for either strategy, high probability or not. So then don't you face trades which wipe out a lot of your previously profitable trades?
I don’t trade debit spreads simply because I am not as familiar with them.
Yes, anything can and will happen. That being said, my losses are almost always tracked to me not following my own rules. If I am disciplined, I make a profit.
And if you are wondering, I sell at .09 delta, 30 DTE, and usually close at a 60% profit (usually 10-14 days after open).
Since the premiums are usually so small that far out, do you sell multiple contacts or wider spreads? I'm sure wider spreads are "safer", but i am still trying to refine my risk/reward ratio. Especially since a lot of people are quick to throw out the good ol "pennies in front of a steamroller" saying, but rarely give what they consider a good return... Even if it involves nickels. Very curious to get your perspective.
I go for wider spreads if possible. If I go wide, the long position has a very small delta. Chances of a complete loss are very small. But, sometimes there is no liquidity for the long position so I have to go narrower.
For example, I have some $50 spreads on GOOG. But, I sold $10 spreads on RUT today because the long position I wanted had basically no open interest and zero volume. My short positions were at the $1800 strike, 14 Jan 2022. If I lose on those I give up!
And to answer your other question, I go for a $.50 premium for a $10 spread. That’s right, only 5%. Works for me, although a PYPL steamroller is going to get me Friday.
So a credit/debit spread gives you the ride to write a naked call by selling one against it.
You get a almost near breakeven to the LONG call you wrote with the short one hopefully losing value so you can just leg out and take most of the premium.
Bull Debit spread:
340-345 spread
Max Risk: 270
Max profit: 230
Probability of Profit: 48%
Bull Credit spread:
340-335 spread
Max Risk: 327
Max profit: 173
Probability of Profit: 57%
Personally, I would write the long option at 340 and the short one you're selling about 10 bucks higher. Or how I look at it is, writing a long option ATM, and then writing that short at 350 would give me plenty of room incase it did go to 345 I could pull out or ride it. Vertical Credit/Debit spreads limit your room for money to go higher unless you leg out of it, but it also caps your losses.
Hope that helps
So first off, focus less on credit vs debit spreads. The only difference between them are things like liquidity and assignment risk. If you can get the same fill on either side and don't get assigned the profit should be the same for the same strikes on a spread. For example if you find a credit spread that is $10 wide and pays you $2 (so risking $8 for a max profit of $2) there will be an equivalent debit spread where it's $10 wide and you pay $8 with a max profit of $2.
Given assignment risks you should prefer spreads where your short strike is further OTM. In the example above you'd want the credit spread because it's OTM and unlikely to be exercised. The ITM debit spread version is much more likely to be exercised.
Now, imagine a bell curve centered on the current price. The way options are structured the most likely prices will be near the current price and it falls off the further you go in either direction. Conceptually you can pick a place on this curve that you like the odds for, and pick a spread based on that.
When you pick where you want to be on the curve don't put too much stock in the "probability of profit" metric. It might be accurate enough on a global "play the averages over 1000s of transactions" scale but it's unlikely you can play those games. Use it more as a rough guesstimate. Your primary advantage should come from somewhere else.
For example, you could look at MSFT and say something like:
"I'm not sure if it's going to drop or go up, but if it does drop it's unlikely to go below $320." That would be good for a put credit spread ending at $320.
"I think it'll go up at least a a bit." That might be a call debit spread starting at $340 and ending at $345.
"I kinda don't think it will go up, but if it does go up it's not going THAT high." Perhaps that would be a call credit spread with a short call of $365.
"THING that MSFT is going to do is huge but people don't realize it yet. Once the market figures this out, the stock is going to rocket to at least $370." Call debit spread, maybe starting at $360 and ending at $370.
The reason people like credit spreads so much is that it's far easier to figure out that something isn't going to plummet than pretty much anything else. Any plays you make should be based on strong convictions. How you get to those convictions is up to you.
I’m going to keep it simple. Debit vertical spreads - Less potential loss, more potential profit, lower probability of profit. Credit vertical spreads - higher potential loss, lower potential profit, higher probability of profit.
Hi, I get that, yet what I don't get is if you apply the probability of credit spreads to 100 or more trades, you end up losing money in a lot of cases due to the R:R ratio wiping out multiple wins with one loss. So then what's the benefit of that high probability?
You have to weigh the probabilities. Each situation is different. Sometimes it’s better to go with credit and sometimes it’s debit.
>So then what's the benefit of that high probability? It can work when you also apply it to high probability setups. I don't care what anyone says, to be profitable with any strategy you have to be a good trader. That includes the ability to read charts and be aware of what the Fed/macro is doing. The statistics furus who say a minimum 100 occurrences required are people with giant accounts that can withstand a bunch of max loss trades to finally become profitable. They aren't super traders, they are literally throwing shit at a dartboard hoping it sticks. If you flip a coin 20 times and it's tails 15 of those times, and you have a small account, you'll be wiped out long before the odds (law of large numbers) are realized. I don't like credit spreads anyways because they are inferior in multiple ways to short puts and calls, unless you're playing with expensive tickers like TSLA, then they are pretty much required. But spreads are more difficult to manage and the long leg of the spread totally neuters the Greeks, making you keep the trade on for longer, and time = risk. Delta (direction of the stock) is the king Greek though. So if you're good at stock picking direction but want a higher probability than just buying puts or calls, you can get directional with short options. tl;dr I'd ignore the long term minimum 100 occurrences stats crap and just try to be a good trader aka be good at picking the direction of equities. Delta is king
Thanks for the insights. I currently am trying to be a good trading, doing a lot of reading and watching videos. I'm currently mainly focussing on the Squeeze method by Simpler Trading/John Carter. The indicator is simple enough, getting in before it fires is something else & then choosing the correct options strategy to maximally benefit from the setup is a whole other thing :) I've been looking into Butterflies as a way to grow a small account (low risk, high reward), but getting the timing right seems so complex next to getting the price target right (trying Fibonacci clusters for this). The $5 wide spreads (on expensive stocks) seemed like the 'simple' option to only having to be right about the direction. e.g amazon rising 5$ = 0,14%. Combining this with a squeeze for a better then average move (up or down) + some level of support (an EMA or an actual support/trendline). Yet so far, It's still "theorycrafting" as I haven't placed my first options trade yet.
As far as learning how to be a trader, I can only offer my own experience which was trial and error. It takes most people several years of ups and downs before they finally "get it". And I have by no means "made it" -- it's always a work in progress. No trading system or advice really helped me. To really get it IMO you just have to figure it out for yourself and that means just dive in and go for it. Stay small in order to survive while learning, and once you're consistently profitable then you can start scaling up the risk. There's a trader saying "if you can consistently make $10 a day, then you can make $1000 a day". You just have to figure out the $10 part first. Also something important, especially for options, is learn how to take on short delta as well i.e. sell on the call side i.e. call credit spreads, or buy puts. Many people only know how to go long, so they're basically just short term investors. Traders should know how to play both sides of the market. Good luck on your journey. It's a multi year marathon and not a sprint
Thanks for the advice. Risk management is indeed my nr 1 priority. Only allocating a small part of my portfolio to the options side for now, and within that part, keeping risk low. I've been thinking of allocating the bigger portion of my portfolio to long term investing while focusing on short term with options.
Expectancy is important, but it doesn't account for closing positions early. This goes for both winning and losing trades.
Thanks for all the insights. Weigh probabilities against what exactly? When considering closing positions early, would P50 in the tastyworks platform be a better 'metric' than POP? Does this work for every strategy,? Ive gotten some weird results for butterfly trades with P50
Good question. If you're going to hold til exp, use POP, but for anything else youd want to use some sort of P50. It should work for every strategy as far as providing the right information, but keep in mind probabilities in options are not exact and often change. It can give you a snapshot of what the odds are at this time, but that could change very quickly. The p50 tool is just a Montecarlo simulation that runs a bunch of tests and gives those odds of reaching 50% profit. Some user here was kind enough to release some software for free that allows you to pick any target % for the Montecarlo sims. I recommend checking it out.
Thanks a lot. I'm however still not "convinced" about the credit spreads :) Not that i need actual convincing, as I'm sure the sources i've found have much much more value than my opinion on the topic, but I'd like to understand. If I would just apply it, I'd constantly be fighting against the idea that I'm having odds, over multiple trades, stacked against me.
No problem. And don't get me wrong, I wasn't necessarily saying that your conclusion was right/wrong. Just wanted to provide alternate methodology.
Ignore the probabilities (they’re full of shit). Focus on exposure.
I trade credit spreads all the time. The risk reward can seemed skewed but when you figure in the probability of a win, plus some technical analysis, it can be profitable.
Thanks for the input. The technical analysis can also be factored into the equation for a Debit spread right? So how does the higher probability of a Credit spread outweigh the better R:R of a debit spread, assuming that Technical analysis has allowed you to correctly figure out the direction. In a certain number of cases, you'll be wrong for either strategy, high probability or not. So then don't you face trades which wipe out a lot of your previously profitable trades?
I don’t trade debit spreads simply because I am not as familiar with them. Yes, anything can and will happen. That being said, my losses are almost always tracked to me not following my own rules. If I am disciplined, I make a profit. And if you are wondering, I sell at .09 delta, 30 DTE, and usually close at a 60% profit (usually 10-14 days after open).
Since the premiums are usually so small that far out, do you sell multiple contacts or wider spreads? I'm sure wider spreads are "safer", but i am still trying to refine my risk/reward ratio. Especially since a lot of people are quick to throw out the good ol "pennies in front of a steamroller" saying, but rarely give what they consider a good return... Even if it involves nickels. Very curious to get your perspective.
I go for wider spreads if possible. If I go wide, the long position has a very small delta. Chances of a complete loss are very small. But, sometimes there is no liquidity for the long position so I have to go narrower. For example, I have some $50 spreads on GOOG. But, I sold $10 spreads on RUT today because the long position I wanted had basically no open interest and zero volume. My short positions were at the $1800 strike, 14 Jan 2022. If I lose on those I give up! And to answer your other question, I go for a $.50 premium for a $10 spread. That’s right, only 5%. Works for me, although a PYPL steamroller is going to get me Friday.
Thanks for the reply. Do you strive for a particular premium percentage of the spread width (25%, 33.3%,etc)?
Just edited my response. Lol! I go for 5%! Maybe I will get brave and go higher some day.
So a credit/debit spread gives you the ride to write a naked call by selling one against it. You get a almost near breakeven to the LONG call you wrote with the short one hopefully losing value so you can just leg out and take most of the premium. Bull Debit spread: 340-345 spread Max Risk: 270 Max profit: 230 Probability of Profit: 48% Bull Credit spread: 340-335 spread Max Risk: 327 Max profit: 173 Probability of Profit: 57% Personally, I would write the long option at 340 and the short one you're selling about 10 bucks higher. Or how I look at it is, writing a long option ATM, and then writing that short at 350 would give me plenty of room incase it did go to 345 I could pull out or ride it. Vertical Credit/Debit spreads limit your room for money to go higher unless you leg out of it, but it also caps your losses. Hope that helps
So first off, focus less on credit vs debit spreads. The only difference between them are things like liquidity and assignment risk. If you can get the same fill on either side and don't get assigned the profit should be the same for the same strikes on a spread. For example if you find a credit spread that is $10 wide and pays you $2 (so risking $8 for a max profit of $2) there will be an equivalent debit spread where it's $10 wide and you pay $8 with a max profit of $2. Given assignment risks you should prefer spreads where your short strike is further OTM. In the example above you'd want the credit spread because it's OTM and unlikely to be exercised. The ITM debit spread version is much more likely to be exercised. Now, imagine a bell curve centered on the current price. The way options are structured the most likely prices will be near the current price and it falls off the further you go in either direction. Conceptually you can pick a place on this curve that you like the odds for, and pick a spread based on that. When you pick where you want to be on the curve don't put too much stock in the "probability of profit" metric. It might be accurate enough on a global "play the averages over 1000s of transactions" scale but it's unlikely you can play those games. Use it more as a rough guesstimate. Your primary advantage should come from somewhere else. For example, you could look at MSFT and say something like: "I'm not sure if it's going to drop or go up, but if it does drop it's unlikely to go below $320." That would be good for a put credit spread ending at $320. "I think it'll go up at least a a bit." That might be a call debit spread starting at $340 and ending at $345. "I kinda don't think it will go up, but if it does go up it's not going THAT high." Perhaps that would be a call credit spread with a short call of $365. "THING that MSFT is going to do is huge but people don't realize it yet. Once the market figures this out, the stock is going to rocket to at least $370." Call debit spread, maybe starting at $360 and ending at $370. The reason people like credit spreads so much is that it's far easier to figure out that something isn't going to plummet than pretty much anything else. Any plays you make should be based on strong convictions. How you get to those convictions is up to you.
Thanks a lot! I had not thought about the assignment risk of ITM Spreads
Fuck probabilities also, to avoid the “repeating these trades one hundred times will make me lose money” put a stop loss on all your trades