Credit spread and cash required.

I signed back up for Esignal on the weekend, copied all my formulas back onto my new computer and took a look over some of the stuff I was working on in the summer.

A medium term trading plan was on the agenda and I was working on a 20 week SMA envelope idea to allow medium term trend trading both long and short.I think I will re-incorporate this into my newer plan.

I was considering setting credit spread trades based on SPY and I decided to check into the credit requirements for this. My gut said just be sure to have cash for the difference in strikes less the proceeds from the sale of the short call. The online CSR couldn't help other than to give me the link to the margin page that I came from. So I placed an example to tell me how much cash I needed...this all due to needing to know how little I need to fund the account with to get rolling.

So I ended up calling the order desk to get the information I needed. With a headspace in the possible complicated zone I had to shut up while the fellow explained exactly what I expected...DUH!

My example was selling the DEC 114 strike ($0.73) and buying the Dec 117 strike ($0.22)

Base cash is difference in the strike times the 100 shares per contract times the number of contracts traded.

$3 X 100 shares X 1 contracts = $300

Subtract the credit generated from the sale, in this case $0.51 X 100 shares and the cash needed is $249, this becomes my Maximum Loss Allowance. Of course the idea is to not need the MLA and to just pocket the $50 do do it over again. In theory I should be able to add another contract to the trading pool after every 6 single contract trades of this level...oh, less commissions. Make that 8 trades

Now, the cash needed is the MLA should the price go beyond the bought strike of $117 as it will cover the short strike at $114. If I close the trade prior to the expiration when it looks like it might cross over then I can reduce my loss accordingly.

Consider that I have $5,000 in the account, only as that is the minimum account value needed to trade options, not necessarily all cash.

Take any trade that has a $3 strike difference and figure that any credit from any trade is going to be in the 20% range of the MLA. I think I can pick far better spreads but this is a start.

Using these numbers:

$250 MLA per contract traded
$50 target profit per contract traded
$10 commission if carried to expiry, $20 if closed early
$1 per additional contract to expiry, $2 if closed early.

I could run 19 trades either single contract or any number up to the 19 contract maximum.

An interesting plan might be to start with the farther out trade, 30 days plus, as singles and add a contract per trade for each day until the maximum trades are reached.

I expect that I can get the better prices farther out given the right circumstances. In fact I bet that I could use the same MLA with the right strike and expiry to gain a larger upfront profit.

Optioneer essential does this but with a fancy proprietary indicator to decide the sold option to start with and the outside protection option is always a certain spread away.

The downside is that this plan is completed taxable. Why is all the fun stuff taxable?

Jeff.