When to close a credit spread
October 13, 2008 by Daniel Beatty
There are two times to close a credit spread…when you are losing and when you are winning big.
I always close a credit spread when the spread goes against me and breaks a support or resistance. However many times there is a need to close a trade when the risk far outweighs the necessity to gain that little bit of extra profit left in the trade by holding till expiration.
Today was a prime example or more likely Friday was a good example. We had 6 consecutive days of down trading and big down trading at that. Most of my Bear Call Spreads that were set to expire this coming Friday had almost no profit left to them. The risk of a bounce was great with 6 days of consecutive down days so it was a time to take profits. Now lucky for me I knew I did not have time to close my trades this morning so I closed them on Friday. At the time I had to fight back the little feeling of greed as I was thinking ahh the weekend will bring me two more days closer to expiration and I would be killing more time premium, but that little voice of fear said hey Friday is the day of the bounce, it is coming this afternoon.
I stopped the mind tlking and stopped the emotions and fixed on the rules. There was very little time left in the trades and they were worth only .15 a contract at the most, so close the trade and take the profit. I did and Friday made a Lincoln’s hat which suggests a turn around for the next day…and BOY what a turn around today was - the DOW up over 900 points and the S&P 500 up almost 100 points! Some of the profit I lost by buying back the sold calls I am going to gain by selling the bought calls tomorrow!
SO when trading credit spreads know when to exit and follow your rules. Keeping to my rules and a little luck helped make my trades this month profitable. Now it is a waiting game again to see what the markets are going to do and look for a trade for next month. I am still bearish and still emphasizing Bear Call Spreads, but I always let the market tell me what to trade - rule one in option trading follow the trend.
bounce, credit spread, fear, greed, risk
I was right in step with you until that final paragraph.
Yes, it’s essential to close spreads when there is little to gain by holding longer. It’s just not worth the risk of loss to gain another few nickels per spread.
But when you suggest that the number one rule of options trading is to follow the trend, I disagree strongly if your basic strategy is selling credit spreads.
To me, the number one rule is to avoid losing money. To do that risk management is essential. ‘Following the trend’ is for people who believe they can correctly predict market direction, and there are very few traders - and that includes professionals - who can do that.
My Rules: And it’s important to follow them in this sequence:
1. Don’t go broke. Survive to stay in the game.
2. Make money
3. Build wealth
4. Never, never forget rule #1
Mark,
I love your rules!!! They fit lock and step with my philosophy of keep it simple and remember the big picture.
I guess my rule is not really a big picture rule but rather a specific rule when looking for a trade. Obviously charts are only a snap shot of the current situation of a stock or index and making predictions as you stated are almost impossible; however it is all about risk and I feel that it is important that as you come looking for a trade you want every advantage to reduce risk that you can and my very first rule when looking for a trade is to not go against the trend.
Hence rule number one when looking for a trade is to go with the trend.
Your rule number one is far more important and that deals with the bigger picture of trading and money management - So I am heartily going to agree with you that rule number one in the big picture is money and trade management - live to trade another day.