Credit Spread Trades

[Zach]

I've been looking at credit spread trading recently, and was wondering if anyone has any prior investing experience with them?

[Fred]

There is no better way to learn than to actually do the trades yourself.

Due to restrictions at work, I am not as free to do this kind of trades as I used to be.

However, for your initial trades, I recommend:
- start small: one contract on each leg
- take a bullish position (human minds are somehow wired to expect "better tomorrow"); besides it is probably a better choice nowadays
- use liquid instruments
- exit quickly
- watch transaction costs: you will be paying on each leg, both times (entering and exiting position)

Good luck.

[TravelingPennies]

Thanks Fred!

[core]

Before I got into P2P, I would spend a good portion of my free time trading credit spreads or spreads like what I think you are referring to.  For every credit spread there's almost always a way to do the exact same thing with a debit spread.  You're "paying" for it either way.  So I'd focus more on the strategie(s) rather than lumping a bunch together based on whether it's a credit or debit when that distinction isn't meaningful.

As Fred said transaction costs can get you.  This is where it's important to choose brokers wisely.  If starting small it's almost a requirement to have a broker without a "ticket charge", or large min fee per leg.  A 4-legged iron condor would cost $60 minimum to put on at one of my brokers with a $14.95 ticket charge.   (And this broker has 'options' in their name!  Worthless.)  Whereas that same trade would cost just a few bucks at a place like InteractiveBrokers.  The difference is HUGE.  I found that it would really influence my decisions.  When a closing trade would cost me $60-70 I was much more tempted to do foolish things, hold it longer than I otherwise would have... maybe clear through expiration if I was feeling gutsy.  Now that I'm using a lower cost broker it's not even a temptation.  Pennies.

This low VIX environment might be a bad time to get started with certain spreads.  Easy to get burned once and never want to get into that strategy again, when in reality it might not have been the best one for current market conditions anyway.  With things the way they are, the risk/reward ratio is even worse than usual for some spreads.

That risk/reward is the one bad thing about most of these.  It's not exactly fun risking $5k to make a few hundred bucks and then have the thing go south on you.  It only takes once, and that could very well wipe out all your profits year to date if you don't stay on top of it.   It's easy to make money month after month and think that you've found the best strategy ever.  Until 'it' happens.

Where I usually get burned is when I take several days off, maybe out of town or too busy with other projects, etc.  I would occasionally come back to find my position in major trouble and my losses would be sizable if I exited like I should.  But if I just hold on things will "probably" end up fine as long as the market doesn't move farther against me.  It's quite the psychological battle.  I've let it ride which leads to many weeks of sleeping with one eye open, watching the charts on a monitor right next to my bed.  Not fun.  Now I generally try to choose months farther out to I have a little bit more breathing room.  It doesn't completely eliminate the issue though.  Always having to keep on top of it and take immediate action even when you'd rather be doing other things that day/week is easily the worst part of it for me.  I suppose this depends greatly on your strategy.

[Bohb Daishi]

This is pretty much the same thing that Core said, but I can't emphasize it enough. One of the most important things you can do starting out is to find a good broker with low transaction costs. If you use an online retail broker like E*trade or Schwab, you will never make money trading. The commissions are simply too high. Take stocks for example: for 100 shares of X company, E*trade will charge you $10 to get in and $10 to get out ($20 total). Comparatively, Interactive Brokers, which tailors to institutional investors and professional traders, will charge you $1 to get in and $1 to get out ($2 total). If you are just a regular buy-and-hold investor, E*trade is perfect for you (because, frankly, the Interactive Brokers website is terrible for anything other than trading). But if you are actively getting in and out of positions, the extra $18 per trade you pay will put a substantial dent in your profits.

You should never have to make a trade decision because you are worried about transaction costs. This is especially true when it comes to scratching a trade that is either flat or down. If don't get rid of your losers quickly, you'll start to get emotional and end up losing even more money than you otherwise would if you just ate the commission.