Answer:   It depends on how much cash you plan to invest in credit spreads for the month.   It’s good not to put all of your eggs in one basket, so it’s probably not wise to invest more than 50% of your portfolio in a single, non-directional strategy such as credit spreads.  Let’s say you have a $100k portfolio and decide to allocate 45% of your portfolio to credit spreads for the next 30 days.  In this case you would open qty 45 of the RUT bull put spreads.   If you want to further diversify, which would be good idea, you would open a mix of RUT, OEX and SPY spreads, the underlying vehicles that we primarily focus on in the monthlycashthruoptions advisory service,  using the $45k.  Each RUT spread, which is a 10 point spread because we open RUT spreads with 10 points between the sell leg and buy leg, requires $1000 of maintenance to open 1 spread.  Each OEX spread, which is a 5 point spread because we open OEX spreads that have 5 points between the sell leg and buy leg, requires $500 of maintenance to open 1 spread.  Each SPY spread, which is a 2 point spread because we open SPY spreads that have 2 points between the sell leg and buy leg, requires $200 of maintenance to open 1 spread.   Back to our $45k, we would allocate $15k to the RUT spreads, $15k to the OEX spreads and $15k to the SPY spreads.   Thus, we would open 15 of the RUT spreads, 30 of the OEX spreads, and 75 of the SPY spreads.   One negative of opening 2 point wide spreads is that we open many more spreads for a given dollar amount, so commissions become a problem.  Thus, we do our best to open more 10 point wide spreads, and fewer 2 point wide spreads.

Answer:   The required cash (risk capital) to open a 3 point wide credit spread is the $300 of maintenance required by the broker, minus the premium that we collected when we first opened the spread.  For the SPY Dec 108/111 bull put spread, we brought in about $25 of premium per spread.  Thus, the actual risk capital per spread for this case is $300 – $25 = $275.  To calculate the number of spreads that would be opened in your autotrade account, you would divide your $4000 cash allocated per trade by $275, which equals 14 spreads.

Answer:   Trading credit spreads on the SPX, the S&P 500 index, is like the Roach Hotel….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 adjustment, such as rolling it into the same month or rolling it into the following month.   In other words, we won’t have many chances to roll our spread if it gets into 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 can 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.

Answer:   The RUT provides the best strike price placement, usually above past resistance levels and below past support levels, while paying a nice premium when opening a bear call or bull put credit spread options.  It also has good liquidity, i.e. a high number of options contracts are traded daily on the RUT, which allows us to easily get into and out of our trades. 

The next best underlying index to trade credit spread and iron condor options is the SPY, (and ETF that tracks at 1/10th of the value of the  S&P 500 index – SPX) but in order to get the best return we need to open 2 point wide spreads, which has a drawback.  (a 2 point wide spread has two points between the leg that we sell and the leg that we buy)  The negative of a 2 point wide spread, as compared to a 10 point wide spread that we would open on the RUT, is that we have to open 5x the number of spreads to allocate the same amount of cash and this has higher commissions.  Also, the liquidity is very high on the SPY….i.e. a million or more options contracts change hands every day – and this is both good and bad.   The good part is that we can easily get in and out of trades….even during volatile times when the market is moving a lot.   The bad is that when the market is bouncing…and let’s say we need to make an adjustment or roll the spread, because there is so much liquidity we have to pay what the market is asking (between the bid and ask prices)  and we rarely can get a special low price that is outside the bidask price range.   On the other hand, if the market is moving a lot and we need to make an adjustment on the RUT, many times we’ll be able to get a cheap price that is outside of the bid/ask prices.

For a case study that compares and contrasts 2, 3, 4, 5 , 7 and 10 point wide credit spreads on the SPY please go to the Learning Center at http://www.monthlycashthruoptions.com/LearningCenter.htm  and read entry #6 – “why we usually open 2 and 3 point wide spreads on the SPY and IWM”.  

Regarding the SPX, you have to be super careful in trading credit spreads and iron condors on this underlying index.  I liken it to Hotel California….it’s really easy and everyone is friendly when you check in, but when things get ugly and you need to get out of your trade, you’ll usually get your head handed to you. (i.e. it will cost a lot to close out your spread and you’ll probably take at least a 25% loss)    Overall, do your best to avoid trading credit spreads on the SPX.

Response:   I would wait a touch longer before jumping into the bear call spreads, if at all.   For the RUT, it would be wise to set our short call at 650 or higher, which is the Jan high.  It’s pretty easy to get burned on the top spreads…so we need to be careful. 

Question:  But it’s interesting to notice with today’s market that even though the DOW is up almost 200 points, NASDAQ 30+ point, and S&P 500 is up 16+, the Call options on these indexes aren’t moving up much.   Why isn’t there much premium on these call options?

Response:    A lot of it comes down to supply and demand and currently there are few speculators that want to buy calls on the major indexes, and rightly so since we might still be in a correction, so the premiums that they are willing to pay are low.   Premiums are low anyway for OTM calls, especially when we’re down to the last 10 days of trade or less before expiration.    We know that  it’s difficult to push a boulder uphill and if we ‘re able to move it, it will move slowly;  however, if we let go it will start to roll down the hill quickly and momentum will build as gravity takes over.   Because the stock market is similar to a boulder on a hill,  we can charge the speculators more for Puts because there is more potential to make money on them if the market has a correction, versus the lower premiums that we are able to charge for the Calls.

Answer:   In a very rare occasion that we get stuck with ITM credit spreads, we will usually roll them and keep them alive….and eventually get 50% to 70% of our money back.   Unfortunately, and fortunately, I’ve become an expert on rolling because some of my spreads went ITM during the Oct 2008 crash, and after rolling them I got back 65% of my maintenance.   Not bad for a total melt-down.  (Just as a side note, most credit spread traders, including editor-in–chief’s from other credit spread newsletters don’t have experience in rolling because most just throw in the towel and let their subscribers take a total loss.  I personally hate to lose money and will fight to the end to get back at least some of my money) 

Answering your question specifically, if some of our spreads went ITM and we didn’t want to roll them but just let them expire, the credit spread on the RUT and SPX (classified as broad based indexes) are cash settled, so cash would be withdrawn from our account.   If the spread went completely ITM and we let it expire, we would lose all of our risk capital, which is the required maintenance less the premium collected.

Per options on the SPY and IWM (which are ETFs that track at 1/10^th the value of the S&P 500 and Russell 2000 indexes, respectively) the ETF shares would be PUT to us where we have to buy the shares at the strike price and the shares would be deposited into our account.

Again, in general with this situation, and this is only for the emergency case where the stock market crashes 12% or more in just a few days and we get stuck with ITM bull put spreads, we will roll our spreads month to month and there is a very good chance we’ll get back at least half of our money, and more like 60% to 70%.

Response:   Regarding liquidity.…yes, if too many folks start trading index credit spreads, for example on the S&P 500 and Russell 2000 indexes and ETFs, the risk/reward characteristics of our credit spreads will become less attractive.  So far, however,  there seems to be plenty of  liquidity and the placement of the strike prices are still good.   Luckily, credit spreads are a lot harder than they look, so a certain % of participants get hit every month, scaring them and washing them out..…so it’s my guess that there will be plenty of liquidity for a long time to come.

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.

Answer:  It’s been frustrating this month, and really over the last 4 months, to easily bring in “safe” premium because every time our recommended credit spreads are filling the window of opportunity is short lived;  three hours here….2 hours there…etc..   (“safe” means credit spreads with a comfortable risk/reward profile as a function of strike price placement and time to expiration)   We were able to open some of the recommended Dec bull put spread options earlier this month, but the market only gave us a few short lived opportunities to do it.   I personally brought in a good level of premium on the RUT 500/510 and SPY 99/101 bull put spreads, but again the opportunities to get the fills were short and sporadic.   Another issue that has made it difficult for us to open more Dec bull put spreads is that all of the recent economic data has been good, which is fortunate for the US economy as a whole, but unfortunate for us looking to open more Dec bull put spreads.  We were hoping that retail sales would come in weak today, Friday, giving us a solid DOWN day, but again we had good results keeping the market steady and trading in a tight range.  The problem we now have is that we’re down to the last week before our December contracts expire, and because the market has been holding steady, it’s almost impossible to open more relatively safe Dec bull put spreads.

For those of you who are anxious to open more Dec bull put spreads, here are some ideas.  Referring to the charts in the Wed, Dec 9th advisory, we show support levels that we should keep our short put strike prices below to play it safe.  None of these trades are sanctioned MCTO trades.

For the RUT, it would be prudent to keep our short put leg below 550;  the RUT Dec 530/540 bull put spread is paying nothing, unfortunately, and the more risky 540/550 is only filling for 20 cents, which is not enough.  When we are down to the last week, unless we have a very strong movement in the index, we usually are done bringing in premium for the cycle.  You’ll notice that speculators have bought a lot of the RUT Dec 580 puts hoping that the RUT will pull back in the next week.   For those who like to gamble, you could open some of the RUT Dec 570/580 bull put spread for about a 75 cents credit, but this is more like going to Las Vegas.  You can see that the 580 level is one of the support levels drawn on the RUT chart in the Dec 9th advisory, and if the RUT has a quick, violent pull back, 580 is its first target.   Just to be clear, this is not a sanctioned MCTO trade. 

For the IWM, just divide the above numbers by 10, and it’s best to open a 2 point wide spread since we are late in the cycle and usually it gives the best returns per unit of risk capital.   (for more on the topic of comparing returns for 2, 3, 4, 5, 7 and 10 point wide credit spreads, please go to the Monthly Cash Thru Options Learning Center at  http://www.monthlycashthruoptions.com/LearningCenter.htm   and read the entry entitled “why we usually open 2 and 3 point wide credit spreads”.   These are not sanctioned MCTO trades.

For the SPY, and referring to the charts in the Dec 9th advisory, it would be wise to keep the short put leg one-click below the 108 level, which represents the 50 day SMA.  Because most economic data have been good in the last few weeks, because there is still fear of a sliding US dollar, and next week it’s a relatively quiet week for economic announcements, the big cap stocks should maintain their strength in the short run.  As of close of the market on Friday, the SPY Dec 105/107 bull put spreads is filling for 7 cents credit, which is not enough.   If it fills early next week for at least 10 cents, this would represent a 10/190= 5.3% return, which is an acceptable return in 5 trading days.  (assuming the SPY remains above 107 through the end of next week)  Remember, options on the SPY trade American Style and will be active through the close of Friday.  Again, these are not sanctioned MCTO trades.

Answer:   As long as the recommended spread is filling for between 45 and 70 cents, we open the recommended spreads using the price that it’s currently filling at on that particular day, and we use about 20% of the available cash for that day.  We then pause and wait for the next day when it’s filling again betwen 45 and 70 cents.  (i.e. we collect premium over time, which helps reduce risk)    If at any time it starts to fill for 71 cents or more, the spread no longer has a 90% probability of expiring OTM and profitable, but it has an 83% (just a guess…but probably close)  probability of expiring profitable.   Because we have the goal of opening 90% probability credit spread options, we then would move our strike prices away from the underlying index ”one-click” so we can bring the probability back to the 90% level.