Important Post for Spread Traders

At times, when being taught something new, the teacher may fail to mention something because it is so obvious. That may cause significant harm to those who require that the obvious be pointed out to them. I remember my own struggles with trigonometry until a friend presented me with an ‘aha moment’ by showing me something (long forgotten now) that made all the difference. After that moment, trig become a snap.

For the majority of new option traders, this lesson is unnecessary. For others it can turn spread trading from something mysterious into something simple and profitable.

THE KEY: A spread is an entity unto itself and the individual options that comprise the spread can be ignored.

Example 1

    If you buy a call spread, do not sell the option you own when it can be sold at a profit. There is no profit. In order for the spread to be profitable, you must sell the whole spread for more than it cost.

Example 2

When trading iron condors: (the iron condor is the sale of one call spread and one put spread on the same underlying asset when both spreads have the same expiration)

    The put spread is not sold to make money.
    The call spread is not sold to make money.

Instead, the iron condor trade is made to make money and that requires covering both the put and call spreads for less than the premium collected.

The put spread is sold as a hedge against being short the call spread. Translation: If we lose money on the call spread, we recover some of that loss by being short the put spread.

The call spread is sold as a hedge against being short the put spread. Translation: If we lose money on the put spread, we recover some of that loss by being short the call spread.

We plan to make money by covering the iron condor position (not only one half of it) for less than the original premium collected, after time has passed and the stock has behaved (traded within an acceptable range).

This may seen trivial, and it is — once it has been learned. However, we were not born knowing this and it is something worth mentioning. I have seen too many iron condor traders cover the put or call spread when it became profitable, and thereby lost the advantage of owning an iron condor position.

3 Responses to Important Post for Spread Traders

  1. Tony BenBrahim 09/27/2013 at 5:57 PM #

    There is an exception when closing the trade. For example, I had a credit spread today where both the short and long where bid at 0, offered at ,01. There is no sense in paying commissions to sell the worthless long side, just sell the short side.

    • Tony BenBrahim 09/27/2013 at 5:57 PM #

      that should have said just buy back the short side.

  2. Mark Wolfinger 09/27/2013 at 8:04 PM #

    Right you are.
    This does not occur too often, but when we can buy the short side for 5 cents or less, we can keep the short side.