Options trading verticals. your size and how to roll the options let me know your
thoughts about whether you prefer to trade verticals or naked options you can
leave a comment below again let me know your thoughts whether you prefer to
trade naked options or verticals and also why if you want to volunteer that
information in that we created you can also go to beststockstrategy.com and
enter in your email address and receive over $400 worth of free training
materials those training materials are better than many people's materials that
they actually charge you for so in this video we're going to discuss spreads
which are also called verticals and the size that you should trade and
additionally how to roll and manage that position so I'm going to try to keep
this very simple because I go in a lot of detail in my
course and I don't want to be disrespectful to the people who
purchased the course so as a result I'm going to be extremely superficial in the
amount of knowledge that provide in this video so that way the people who
purchase the course are able to derive substantial value from it but basically
the biggest mistake that I see people do when they trade spreads is that they
trade too large remember that when you trade a spread the primary reason that
you're doing so is not necessarily for the to turn the undefined risk trade
into a defined risk trade because for the most part the times that you're
actually going to use let's say you're selling a put spread
the percentage of times you're actually going to utilize that
put that you bought is extremely low, maybe 1% or so. The primary reason that
people are going to end up trading spreads is because it provides a higher
return on capital and it allows you to have more capital efficiency. For example
let's say you're going to sell a $1500 put on Amazon that is
then going to require you if you sold it naked around $60,000 dollars of
buying power reduction because, remember it's the buying power reduction is
calculated as 20% percent of your maximum loss so if you
sell a $1500 put
then it would be $150,000 would be the notional value the maximum loss
per contract and then 20 percent of that would be $30,0000 dollars as a
result your buying power would be reduced by thirty thousand dollars now
if you trade a spread let's say you were to trade you would sell the same fifteen
hundred pudding you will buy the 1450 it's a $50 wide spread as a result
you would only have a buying power reduction of around a $1,000 dollars
and that's calculated because you have $50 multiplied by a hundred shares there
would be five thousand dollars and then maximum loss and 20 percent of that
would be a thousand so there's a major difference between $1,000 deduction and
a $30,000 dollar buying power reduction and that's the primary reason
that people choose spreads is that it provides a higher return on capital
The problem with spreads is that a lot of people trade too large if they are
able to trade let's say 2 or 3 naked options instead what I see people
do who end up losing money is they will trade 20 spreads and that's not
something that you want to do you do not want to trade five or six times the
number of contracts that you could possibly trade as a naked option and you
don't want to trade five or six times more spreads just because of the greater
capital efficiency. Going back to the Amazon example, remember selling the
spread in that specific example is 30x more efficient that means that
from a buying power perspective you could technically sell 30 $1500 / $1450
spreads for every one $1500 naked option that you sell and realize the same
buying power reduction the problem with that is that if the market has a bad
week and it starts approaching that $1500 strike your broker is going to
force you to close out those positions because you're gonna have a tremendous
amount of exposure now in the worst case scenario if Amazon actually falls below
1500 and it starts trading around
1475 and you're gonna be in that no-man's land where it's going to be
it's going to be below the short put that you sold and above the put that you
bought there for leading the fifteenth therefore causing the 1450 put to
essentially be worthless. Yes, it's going to provide you some downside protection but
if the stock price ends up in the middle then you're not going to be afforded any
type of us because you can't afford to take ownership of that stock and because
you trade it's large you're probably not going to be able to roll and manage that
position your broker is going to force you to close out that position you're
going to be the margin call and you're going to sustain massive losses. I can't
tell you enough how many times this happens. Remember your goal should always
be to make less money when the market is going well so that you can lose a lot
less money when the market is doing poorly.
For example during 2018 between late March and September everything was going
great during that scenario you should have
actually been taking on a little bit less risk and maybe earn like 1% less a
month because that would have set you up and that would have established positive
habits so that when October and December rolled around you lost a lot less money.
Because you never want to be in a situation where you have a month or you
have a sequence of events where you lose so much money that it takes you six
months or a year to recoup that money so again you want to get in good habits and
I know that you want to make as much money as quickly as possible, everyone
does. But I'll tell you that the loss is hurt a lot more than the gains feel good
And you want to make sure that if you are trading spreads which is completely
fine but you really don't trade too many of them. This is something that I teach
in my options trading course in the education course you can go to BestStockStrategy.com/memberships
beststockstrategy.com/memberships and enroll to be a member we go in much
greater detail regarding the specific ratio of spreads to naked options that
you should sell we also get into rolling. Rolling a spread
is very difficult so I do get into some strategies in the education
course but the primary reason for making this video is I wanted to
tell you that you have to make sure that when you trade spreads do not given
to the desire to try to make quick and easy money and you don't trade too large
because in the example that I gave previously when you sold the 1500 by
1450 strike on Amazon that transaction the way that you structured it woul have lead to big losses.