Question about January auto-trade trades and diversification of the trades

Question:  I am a little confused by the number of options trades placed in my auto-trade account  for January.  I had assumed that you would place about five trades per month and these trades would be for different indices.  When you place three trades for one index and one trade for another index, does this mean that you are not going to place trades in the other indexes you usually trade for the current month?

Answer:    So far we’ve placed 4 options trades in the auto trade accounts for the January cycle.  Three, 2 point wide SPY credit spreads and one, 10 point wide SPX credit spread options.   We  send a maximum of 5 trade alerts each month that uses 100% of your cash, and so far we’ve sent four.  (at least our goal is to send 5 auto-trade trade alerts, but sometimes we’re not able to invest all of your cash for a particular month….like in the last 3 months due to how the market has been behaving)

The reason we’re focusing on the S&P 500 index this month is that we’re a little concerned that the RUT might spike-up to play “catch-up”….so we’re under weighting on the RUT and over weighting on the big-cap S&P 500 index this month.  Because the US dollar is strengthening, this also will put a little downward pressure on the big-cap stocks that reside in the S&P 500 index, which gives us a higher probability that our top January bear call spreads will expire profitable.

Per the topic of diversification, because these are indexes, they are already diversified since each is composed of hundreds, if not thousands of stocks.   The big cap index does move a little differently as compared to how the mid-cap and small-cap indexes move, so this does provide a small amount of diversification, but we don’t want to use all of these indexes just for the sake of trying to diversify.  We  look at each index as a independent trading vehicle and if the technicals, strike price placement and levels of premium look good offering us a decent risk/reward profile, we’ll open the trade.    In the process,  if we’re able to open credit spreads on multiple indexes giving us a little bit of added diversification, all the better.

Comments (2)

Bob WilberSeptember 30th, 2010 at 10:14 pm

Given that SPY is essentially 1/10 of SPX what is the point of having spreads on both? You need to buy and sell 10 times as many options on SPY to have a trade equivalent to a SPX credit spread so the commissions are worse. The tax treatment is worse. And the options are American, so there is at least the possibility of being stuck with early assignment on the short options.

bradrrOctober 2nd, 2010 at 11:53 pm

Trading credit spreads on the SPX, the S&P 500 index, is like Hotel California….you can check in, but you can’t check out. Opening credit spreads on the SPX seems to be just fine and it feels great to bring in a solid 9% premium on a 90% probability spread that has less than 30 days to expiration. However, even though there is a lot of liquidity on the SPX options, it doesn’t act like it where if our trade gets into trouble, it will cost 20% to 30% of our risk capital to make an ajustment, such as rolling it into the same month or into the following month. In other words, we won’t have many chances to roll our spread if it gets in trouble and we’ll pretty much be taking a 50% to 60% loss after rolling it just 2 times, which is not good. When trading credit spreads on the RUT, for example, if our spreads unexpectedly go in-the-money, it’s quite possible to roll it for 6 to 9 months, if required, and we could still get back at least 50% of our maintenance, and sometimes as high as 70% of the original maintenance. One possible reason that it’s difficult and expensive to make adjustments on SPX credit spreads is that it’s only traded on one exchange, the CBOE, and not on the other 7 exchanges. In contrast, options on the RUT are traded on 6 exchanges, and options on the SPY are traded on all 8 exchanges. It seems that the more exchanges the options are traded on, the more competition there is and thus the cheaper it is to make adjustments on the trade if necessary.

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