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Question from DC:
I notice that many of the services and information aimed at option
trader wannabes do promote front month credit spread selling – why is
Is it because the simpler they can make their systems seem,
the easier it is to sell?
The profit potential – on an annualized basis –
is MUCH higher with near-term options. It's very attractive to attempt to earn 5% in two or three weeks.
Most services talk about the great profits they earn and how you can do
the same by paying for their advice.
The problem is that those high returns come with added risk.
If the market moves against the position big time, then the front month
options are dangerous for two reasons:
They are less far out of the money to begin.
If you move too far OTM, the premium becomes tiny.
That means they move into the money more frequently than options that
are farther away. Once ITM, the delta of the short options approaches 100 quickly (due to
negative gamma) – much more quickly than the delta of longer-term
Losses mount much more quickly when the delta is high. that means the
spread approaches its maximum value more quickly
Bottom line: front month is more attractive to most traders
because you earn your profits quickly, the returns look huge (and they
are huge), but risk is much higher and those services seldom, if ever,
talk about that aspect.
Short-term is NOT wrong. But you must be willing to take higher risk
for better rewards. Personally, I prefer less risk, less reward. But
you may prefer the 'more exciting' near-term game. You would not be
wrong to do that – but do be careful about how many contracts you trade
at one time. The terminology for that is: don't trade too much size.
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