"How To Manage Options Spreads?"

"How To Manage Options Spreads?"

"1. If I am doing a spread, how do I decide when to liquidate the position and when to wait until expiration? 2. If one of the sells gets bought away, should I immediately close the whole position? 3. At what point would I decide to roll over a spread into another? "
- Asked By Paddy on 8 April 2009

Answered by Mr. OppiE

Hi Paddy,

A lot of beginner options traders frequently find themselves in a situation of asking themselves how an options spread is to be managed only AFTER placing the position. This leads to unnecessary frustration, panic and loss of capital. I would advise all beginners to understand completely the following aspects of an options trading strategy (spread) BEFORE using it;

1. Understand Its Function
Options spreads are designed for very specific purposes. You need to make sure you are using it exactly as it is designed for.

2. Understand Its Method of Entry
Some options spreads need to be legged in seperately while some needs to be put on simultaneously. Incorrect entry may eliminate the effectiveness of some options trading strategies.

3. Understand Its Position Maintenance
All options spreads have their own position maintenance strategies and methods. Only when you are 100% clear about this will you be able to manage your options spreads throughout its life profitably.

4. Understand Its Exit Strategy
All options spreads have their own exit strategies. Some options trading strategies need to be held to expiration while others allow some changes in order to make a synthetic close or change its nature completely.

If you had all of the above sorted out before placing a position, you would have no problem at all.

Now, back to your question.

Your first question was answered by point number 4 above. You need to understand the exit strategy of the particular options spread that you are using. In general, credit spreads should be held to expiration in order to maximize its profitability as they typically profit from time decay. Whether or not to liquidate a position prior to expiration is also a decision you must make taking the probability of the stock still performing within the expectations of the options spread into consideration. However, all position traders would have a pre-defined maximum loss calculated before a position is placed, so if you don't have this worked out, you may need to make sure you do the maximum loss calculation for your selected options spread before using it.

Your second question has to do with point number 1 above. I am not sure what you mean by "one of the sells get bought away" but in general, any options spreads that are not complete would not perform the way you expect it to perform. In fact, options spreads with missing legs might perform completely opposite to what you set it up for initially. For example, a Bull Call Spread missing its long call leg would instantly transform from a bullish options strategy to a naked call write, which is a BEARISH options strategy. You should immediately repair that position or simply close it off completely.

One of the magic of options trading is its versatility. All options spreads can be transformed into another options trading strategy without closing off the whole position. For example, a Bull Call Spread can be instantly transformed into a Bear Call Spread by closing the long call leg and replacing it with a short call. However, that's where the confusion starts for beginner options traders. Whether or not to roll it forward or transform it into another options trading strategy has to do with whether or not your initial outlook on the underlying asset has changed. In general, your outlook hasn't changed, roll foward. If your outlook has changed, either close the position or transform it.

In conclusion, there is no one best answer to any of your questions today because they can only be answered by yourself if you have fulfilled the 4 points tip that I mentioned above. Position management is critical to the success of an options spread and complete understanding is necessary prior to the use of any of them. My answers to you today are extremely general and will not be a good fit for your specific situation. As such, you should work on the 4 points tip and make sure you apply them in future.

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