Question about overlapping strike prices when trading credit spreads on the RUT Index
I have a question regarding overlapping strike prices. In your FAQ section, under the heading under the heading of “Why do I need multiple accounts when trading credit spreads and iron condors on the RUT?”, you advise against overlapping strikes, but rather to open a second account if we want to buy and sell the same strike.
However, under the heading “What % of my trading capital should I use in a single day?”, the third & fourth paragraphs read as follows…
“RUT Bear Call Spread
Buy to open RUT May 560 call
Sell to open RUT May 550 call – For a credit of 40 to 65 cents. If this spread starts to fill for more than 65 cents credit, suspend any further fills on it and click-up a strike to keep your credit between 40 to 65 cents. “When the market is having an UP day, there is a good chance that this spread will fill for at least 40 cents credit. When the market is having a DOWN day, most likely this credit spread will not fill for the minimum of 40 cents, so we just wait until the market has an UP day before trying to fill it again. When this recommended credit spread is filling for at least 40 cents credit, we would recommend for the trader to slowly “collect” premium and maybe use 15% to 20% of their trading capital on that day. We then pause and wait for the next UP day where this spread is again filling for at least 40 cents, and preferably for more, up to 65 cents and we’ll use up maybe another 20% of our cash. If the market continues to climb, and if this spread is now filling for 68 cents, for example, we would suspend fills on this spread, per the directions in the advisory above, and we would “click-up” to the RUT May 560/570 bear call spread and repeat the process of “collecting” premium on the days where it’s filling for at least 40 cents, but no more than 65 cents. Patience is of the essence here where we might have to wait 2, 3, 4 or more trading days before we’re able to fill this spread again to use-up another 20% of our trading capital. If all goes well, the market will continue to climb allowing us to “put to work” all of our trading capital before it stalls and changes direction.”
If we follow these directions, this will give us an overlapping strike at 560. If we use this method of “clicking up”, are we advised to do so in a second account (not mentioned in the Q&A)? Or is this “rule” sometimes broken?
ANSWER – I should have mentioned that this new 560/570 spread will need to be put in the other account. I will update the FAQ page. Thank you for pointing this out.
Secondly, what is wrong with overlapping strikes other than buying and selling the same strike and incurring two broker fees? Are there any other drawbacks or disadvantages?
ANSWER – Our goal is to complete the iron condor each month….i.e. we have both a bull put spread and a bear call spread. In order for the broker’s computers to recognize that our bottom and top spreads should be combined together to create an iron condor, both need to have 1) the same expiration date; 2) be on the same underlying index 3) have the same spread between sell let and buy leg….in this case a 10 point spread. If we were to hypothetically have a Aug RUT 430/440 bull put spread in our account, and then we had a RUT Aug 550/570 bear call spread in that same account, the broker’s computers would not recognize these two spreads as an iron condor and you would be required to hold maintenance on both spreads. (since the bottom one is a 10 point spread and top one is a 20 point spread). However, if both the bottom spread and the top spread are 10 point spreads, you are only required to hold maintenance for one of them….in essence, you can open one of them for free.
I fully understand the advantage of an Iron Condor over either a single Bear Call or Bull Put spread, since at expiration only one of them could potentially cause a loss. However, since the market is more likely to take a much deeper dive on bad news, rather than a very large surge on positive news, would it be advisable to only play only Bear Call trades. I am concerned that some catastrophic world event similar to a 9/11 could wipe out much of my portfolio overnight if a substantial amount was invested in Iron Condors or Bull Put spreads. For instance, if 60% of a portfolio in invested in mostly iron condors (or bull puts), that 60% could be lost overnight. I have seen your portfolio of the 2008 crash and the loss was manageable. However, that crash happened over a period long enough that adjustments could be made.
Hi Matthew,
Yes, I understand your concern. In general, because we open very far out-of-the-money (OTM) 90% probability credit spreads, we tend to have enough time to close out our bull put spreads and/or make adjustments to cut our losses in the case of a market meltdown. 99% of the time, even when the market pulls back hard, we have time to get out and cut our losses, and we have a 5 year track record of keeping our losses below 10%, which is pretty good.
However, the October 2008 crash was different where we unfortuntely ended up riding a few of our spreads down to where they went in-the-money (ITM). This happened because in addition to the major indexes violently selling-off 3% to 5% per day, volatility also rapidly spiked up to record levels making it very expensive to get out of our spreads. We therefore decided to hold-on hoping for a short lived bounce so we could get out, but unfortunately that never happened as we all know. So during the Oct ’08 crash, we actually made very few adjustments to our bull put spreads, thus they they went ITM, and we were able to eventually get back 65% of our original risk capital purely by rolling our ITM spreads month-to-month, rolling down the strike prices lower and lower each month, and waiting for the market to rebound a little. This Oct ’08 crash gave the MCTO team a good case study on what it takes to roll spreads and to recover a large % of risk capital after a massive crash. It was painful to go through, but I’m somewhat happy that it forced me and my partner to become experts on rolling in order to preserve capital during a crash.
So per your concern of a one day, 15% or greater stock market crash where our bull put spreads immediately go ITM, we have a lot of experience with what it takes to roll spreads and we we feel confident that we can get back at least 60% of our risk capital, and maybe even as high as 75% of our risk capital. (e.g.
a nuclear device is detonated in a US city by terrorists, which is one of the few types of events that I can think of that would take the markets down 15% or more in a single day)
Please keep this in mind as you interview other credit spread advisory publishers. Very few, if any, credit spread newsletter editors have experience in rolling. Most don’t bother with rolling and just throw in the towel and let their subscribers lose 100% of their risk capital. For us, that’s unacceptable and we fight to the end to preserve our capital using advanced rolling techniques that we practiced and refined during the Oct ’08 crash.