Question about why we recommend two accounts when trading 10 point wide credit spreads on the RUT

Question:   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 Profit and Loss 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.

Answer:   Yes, the risk reward for the credit spread is the same whether the spread is 10 points wide or 20 points wide.  However, we recommend that our subscribers have two accounts when trading 10 point wide credit spreads on the RUT because we want to maintain maximum flexibility to allow 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.  (i.e. if we have a 10 point wide bull put spread, we have to open a 10 point wide bear call spread to complete the iron condor)    It is true that if we end up creating a 20 point wide spread on the bottom 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 it’s not that simple and we are alternating between opening the top spreads and the bottom spreads, and we are moving our strike prices around as the underlying index is moving, so it’s better to keep all of our spreads 10 points wide giving us maximum flexibility and the best chance to complete the iron condors on all of our trades.

Comments (2)

Wayne LungNovember 22nd, 2010 at 12:41 pm

I am a new subscriber to this advisory system. In the past, I only used SPY or IWM in my credit spreads or iron condors. Recently, I am seeing more positives in using index, specifically the RUT. But, I still have one problem with RUT. There is settlement risk with RUT that you don’t have with IWM. How do you respond to this? To be sure you’re understanding what risk I am talking about, I mean that the price of RUT that is used to determine whether my strike is ITM or OTM is the opening price of this index on Friday when I can no longer trade out of it, as it expires Thursday. So, there can really be surprises when I see that my strike seems to be doing fine Thursday but then, say, Friday is a strong UP day and my short call goes ITM and I have no way of closing it then.

bradrrDecember 2nd, 2010 at 8:05 pm

Hi Wayne. Yes, we do need to be aware and careful with settlement risk. European options, like the options that trade on the RUT, MID and SPX, cease to trade on the last Thursday before expiration and then settle on the last Friday before expiration. Once the options cease to trade on Thur, we can no longer trade our options and are at the mercy of the settlement price that is calculated Friday AM, which is usually published by Friday afternoon on the CBEO website. In general, we need to keep reasonable buffer between our short option strike price and the underlying index, and if we are within 15 points or less, we usually close our spreads out early before cease of trade on Thursday. If the market has high volatility we might want even more buffer, possibly as much as 20 points on Thursday, and if we don’t have this much buffer we would close the trade early on Thursday.

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