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MrTopStep gives futures traders a view from within. From the floor of the CME to trading screens, experienced professional traders offer their observations, insight and knowledge to help you improve your mastery of the markets.
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  • Trading Primer: CREDIT SPREADS AND COMPRESSION TRADES 1 comment
    Oct 18, 2011 11:51 PM | about stocks: AAPL

    I became enamored with the financial markets early on in life as my Grandfather came from the old school of investing - he made his millions in the bond market without ever setting a foot near Wall Street. In my eyes my grandfather was brilliant as he told great tales of 12% yields on no risk investments.  He would pour over his Washington Post each day and jot down notes in his tiny bound ledger, always in pencil as if he would have to erase.  Codes for bond type and term, codes for CD rates and issuers - all recorded carefully in neat block print that grew stiffer and tinier over time.  My Grandfather abhorred the stock market and wrote it off as a bunch of crooks and thieves.  I graduated high school in 1987, the year of a great crash.  This was my Grandfather's proof that the market was indeed corrupt.

    Guess what?  I grew up and became a money manager, a calculated risk taker - a trader...I wonder what he would think of me now.

    I tend to be very simplistic in discussing my job as a trader.  My job as a trader is two-fold - capture price movement with the least risk possible.

    I've tried on many different trading hats over the years:  Investor, Swing-Trader, Day Trader, Options Trader, Futures Trader, Bear Only, Bull Only, Range Trader, Gunslinger.  I've made thousands in a day and lost thousands in an hour.  I had absolutely no discipline THUS no consistent profits until I found the mainstay of my portfolio management - credit spreads.

    Successful options traders capitalize on volatility.  We sell it when it is high and buy it when it is low.  As a retail trader I've found credit spreads to be a safe method to capture the volatility, including trading earnings volatility.  I also find this method extremely easy to maintain for those trading while working a day job, or those running multiple accounts.

    Earlier today i posted an AAPL chart on the MTS chat that was a good set-up for an earnings compression trade. (see annotated chart)

    tinyurl.com/3frhwkt

    This name has a history of running pre-earnings and selling off post-earnings.  It is an identified behavior pattern, thus an actionable event.  Combine that with the technical setup of an island reversal with downside gaps to be filled and you've got a great candidate for a compression trade.  I sold to open a bear call spread position, AAPL Nov 465/460 for a net credit of $1.00.  My max risk on this trade is the spread $5 less the credit $1.  AAPL reported earnings after the close and the stock gapped down hard to $388.91 - volatility will suck out of the calls on the open tomorrow and I will close my trade for a nice profit.  The volatility sucking out is called compression and you can exploit that on either the call or the put side. 

    Volatility can be found within every options expiration (OPEX) cycle making a nice income stream for the prudent options writer.  The key to safe credit spreads is to identify price points, well under major moving averages, with adequate premium available for the risk.  Think way, way, way out of the money calls and puts.  Once you find reliable credit spread candidates, you can trade them over and over again.  AAPL is especially nice for credit spreads as it offers weekly options that are listed the Wednesday before their expiry and begin trading the Thursday before their expiry.  They are notated AAPL W1, W2 etc.   I generally start off with a monthly credit spread and then work into weeklies via bull put spreads or bear call spreads according to the current market environment.  My goal with credit spreads is to sell the volatility while retaining a loss limit, taking in the credit and having both options expire worthless.  I've made my money up front, so all I care about is having the stock close above my short option strike.  I always err to the side of caution and take less premium for less risk.

    Since employing this strategy I find my portfolio is relatively stable and grows by acceptable returns each month.

    Suz

    Themes: CREDIT SPREADS, VOLATILITY Stocks: AAPL
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  • bachagaloop
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    Comments (5) | Send Message
     
    I like it Susie, I want to master spreads
    19 Oct 2011, 11:47 AM Reply Like
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