Some traders are uncomfortable with the idea of a trade that has an undefined risk. They can watch more of tastylive, read entries on the learn page watch videos from our archives and read our blogs to get more comfortable. In the meantime they can use defined-risk trades like spreads. Some benefits of spreads are, lower capital requirements, fixed maximum profit and loss and the ease of calculating your probability of success. There are some simple rules we think you need to follow when using spread trades as a strategy. What are those rules?
It’s important to manage winners at the levels our studies show to be the most profitable. The Market Measures from August 12, 2016, "Russell Index: Put Calendar Spreads" indicated that managing winners in the range of 10%-25% was best. Profit targets for a Vertical Spread (50%), Iron Condor (50%) and an Iron Fly (25%) indicated the percentages we like to manage winners for each strategy.
Managing losers is even easier. We take the maximum loss because of our "trade small, trade often" mentality. When you establish the trade make sure you can handle a total loss at order entry. A table of two losing scenarios trading an Iron Fly demonstrated why we stick with the trade and hold losers to expiration to let the opening Probability Of Profit (POP) percentages play out. A final table helped in the discussion of setting up vertical spreads correctly. We believe in collecting ⅓ the width of the strikes when trading a credit vertical spread. Tom and Tony explained why.
Tom noted, "there is not this huge benefit in trying to play defense to something you already know what the risk is. For naked positions like Straddle and Strangles, we will adjust the positions and roll them to play defense."
For more on Spread Trades see:
tasty BITES from September 30, 2015: "Credit and Debit Vertical Spreads"
Options Jive from February 23, 2016: "Do's And Don'ts Of Exiting Defined Risk Trades"
Options Jive from June 16, 2016: "Credit & Strikes for Spreads: Why 1/3 of Width Works"
Best Practices from August 17, 2016: "Vertical Spread Mechanics"
Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for the key takeaways and to learn the mechanics of properly trading spread trades.
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