7/26/2019 The Stock Trading Mood

http://slidepdf.com/reader/full/the-stock-trading-mood 1/2

19/5/2016 The Stock Tr adi ng M ood: S&P500 Si mpli fied : Sel li ng Naked Options vs Cr edit Spr eads i n SPY

http://the-stock-trading-mood.blogspot.ca/2013/10/selling-naked-options-vs-credit-spreads.html 1/2

Questrade, My direct access discount broker.

Wednesday, October 9, 2013

S&P500 Simplified : Selling Naked Options vs CreditSpreads in SPYLately I've been tinkering with credit spreads and naked puts in SPY, more out of curiosity than anythingelse... that is until I did some extensive studying of the historical SPY data. More on that another timethough.

I have dabbled in options before and made out very well.... and not so well in varied proportions. The onestrategy that I did have a 100% success rate (albeit with not as many trades as would be needed to provefeasibility) with was the credit spread. It was short lived due to my need for continued testing of otherstrategies and styles of trading, which is now one of those hindsight stories.

The basic credit spread plan is to sell an out of the money option and buy a further out of the moneyoption with the same expiry. The first is the profit and the second is the protection. The risk is fixed andis the difference in the strike prices less the premium collected. The trouble is getting enough premiumdifference between the two transactions to be profitable which made me consider the naked option.

Naked option selling looks much more lucrative up front as selling the option without the need for aprotective leg purchase means that all of the premium collected is kept. This often allows the sold optionto be farther out of the money and still be profitable. The trouble is that the risk is no longer defined.

With a naked put, if the price plummets the loss becomes the difference between the strike price of theput and the price of the underlying at expiry. Not that a stock is going to hit zero but a large down movecould be a real problem. This is the point where my SPY study comes in to provide some historical contextfor the risk involved.

While the naked options look enticing for the reasons mentioned and the credit spreads look to be a saferbet, the upfront account management implications for both need to be considered and compared.

Account size.

A typical broker may have a $5,000 minimum account balance in order to trade credit spreads  whereas$25,000 is required to sell naked options. This makes the credit spread more accessible to the small

account holder or hobby trader. Anyone halfway serious can probably start with enough to choose eithermethod but only if they are comfortable and confident in the plan and have at least $100,000 would theyreally be able to use naked option selling.

Margin requirements.

The credit spread requires the entire potential loss to be in the account... so, technically, margin is noteven being used. With a spread that covers a $1 strike price range, this amounts to about $100 per contractand the margin does not change with the price of the underlying stock . This is also the entire amountrisked, less the premium collected, on the trade. It will vary with how wide the spread is in increments of$100 per strike per contract. Because the protective put will be exercised to offset the naked put in aworst case scenario, there is no chance that there will be any assignment of the stock or ETF.

For a naked option this amount is more variable and is not the entire risk associated with the trade. For a$100 stock the margin required might be in the $1,500 range whereas a $200 stock could be around$3,000. It varies with how far out of the money the option is and how much premium was collected forit. The margin requirements also change with the stock price.

These differences make the credit spread a more viable trading method for those with small to mediumaccounts as naked option trades will tie up much more cash per transaction.

For example, a naked 140 put for November expiry sold for 19 cents on September 30th. 10 contractswould yield $170 after commissions but based on a margin requirement of $24,860 which is an ROI of 0.68%. That is one trade.

A credit spread between 141 and 135  strikes sold at the same time with the same expiry would yield 7cents net. It would take 42 contracts in one trade to equal the cash return of the naked option using$25,000. The advantage is that four separate trades could be placed at varied times and dates which couldbe at different strikes based on the price movement and these can be staggered in a way to reduce thechance of a price move producing a loss. Four trades of 10 contracts each that I am currently trackingare from September 30th, October 3rd, 7th and 8th with 10 contracts per trade which can yield a combined$200 profit after commissions based on a margin requirement of $23,800 or an ROI of 0.84%.

A quick note, both the naked puts sold and the credit spreads that I track are set up such that they have asuccess rate of better than 98% over 20 years . Even then the few times that they were "losers" appear to

have been easy to close before they were a total failure... which is more important with the naked optionsthan the spreads.

(UPDATE: I am investigating strategies based on historical statistics and current data that will serve toincrease the returns on risk and maybe even increase the probability of the trades being winners.) 

Jeff.Posted by JDMoodie at 9:30 PM 

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The Stock Trading MoodThis is a bit of a compilation of what I have been, and am now, going through to be successful at trading stocks

for fun...and for profit.

7/26/2019 The Stock Trading Mood

http://slidepdf.com/reader/full/the-stock-trading-mood 2/2

19/5/2016 The Stock Tr adi ng M ood: S&P500 Si mpli fied : Sel li ng Naked Options vs Cr edit Spr eads i n SPY

http://the-stock-trading-mood.blogspot.ca/2013/10/selling-naked-options-vs-credit-spreads.html 2/2

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About MeJDMoodie

I started a blog for sharing trading information...then I started a bit for writing... so who knowswhat I will do next. My daughter tells me I have

ADD because I cannot keep at the same thing forlong.... I think getting a new hobby every year orso doesn't count though.

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