Question about opening credit spreads on the Russell 2000 index, RUT, and needing 2 accounts

Question:    I have been reading the FAQs  on your site.  When reading the:   What % of my trading capital should I use in a single day? I ran into a problem.  It advises filling a Bear Credit Call for May in two tiered steps as follows :

Buy to open RUT May 560 call 

Sell to open RUT May 550 call  –   For a credit of 40 to 65 cents.

Then it goes on to say:   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.   But are you not then overlapping this new spread with the previous one and thus opening up a 20 point spread of May 550 / May 570 ? The May 560s will cancel each other out.  Would this then require trading in 2 separate accounts ?

Response:    Yes, when trading 10 point wide spreads, like what we do with the RUT, we need two accounts.  That is, we need two accounts if we want to be nimble and click-up and click-down our strike prices as the underlying index moves, which ultimately reduces our risk.  Some credit spread traders/newsletters don’t click-up/down during the month, which is rather unfortunate because this increases risk, and you wouldn’t need two accounts.  Per how we do it at MCTO, we do recommend for our subscribers to have two accounts. 

One way of eliminating the need for two accounts is to mix RUT credit spreads with IWM credit spreads.   The IWM is an ETF that tracks at 1/10thof the RUT.   For example, if we recommend the RUT 570/580 bear call spread (which is a 10 point wide spread…i.e. 10 points between the buy and sell legs), the IWM 57/59 bear call spread (which is a 2 point wide spread) has almost the same risk/reward profile.  So for example, let’s say we first open the RUT 570/580 bear call spread.  One week later the RUT rallies and we decide that we need to click-up to move further away from the underlying index.  Because we want to do our best to maintain 10 point wide spreads in our account, we shouldn’t put the RUT 580/590 into the same account that already has the RUT 570/580 since this would create a RUT 570/590 bear call spread, which is 20 points wide.  So an option is to put the IWM 58/60 bear call spread into the account.  Then if the RUT continues to rally and we decide to click-up again, we go back to the RUT and put the RUT 590/600 in the account…..etc.  We also call this “layering” our spreads.  The disadvantage, however, of opening 2 point wide spreads is that higher commissions eat into our returns, so it’s best to use low cost options brokers, like eOption or TradeKing.

Comments (2)

Bob WilberSeptember 30th, 2010 at 3:18 pm

Having a May RUT 550/560 bear call spread in one account and a May RUT 560/570 bear call spread in another account is exactly the same as having a single May RUT 550/570 bear call spread. The P&L is exactly the same. The net Greeks are the same. The margin required is the same as the total margin required for the two separate accounts. So it makes no sense to have two accounts. Just keep the net position in one account.

bradrrOctober 2nd, 2010 at 11:05 pm

Yes, the risk reward for the credit spread is the same whether the spread is 10 points wide or 20 points wide. However, we strongly recommend that our subscribers have two accounts when trading the RUT because we want to maintain maximum flexibility allowing us to open the other side of the spread to complete the iron condor. In order to complete an iron condor where maintenance is only held for one of the spreads, both the top bear call spread and the bottom bull put spread need to have the same point width between the sell leg and the buy leg. It is true that if we end up creating a 20 point wide spread on the bottom that we can easily open a 20 point wide spread on the top to complete the iron condor…and this will work. However, for most months we are alternating between opening the top spreads and the bottom spreads, so it’s better to keep all of our spreads 10 points wide giving us maximum flexibility to complete the iron condors.

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