Lesson Overview

Options Strategies We Don't Adjust (And Why)

It's always important to clarify which options strategies we don't adjust typically and why. Again, it's not that you can't adjust these if you wanted to, but for us it's not worth focusing on strategies that are used as a hedge more often than a core income generating position.

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In this video, we're going to talk about some options strategies that we don't adjust and why.

Before we get into our big picture adjustment strategy and specific techniques on adjusting different types of traders, it's important that we talk about strategies we typically don't adjust and why.

Mainly it comes down to a couple of net buying strategies. In particular, the ones that we usually don't adjust or really will never adjust are debit spreads and ration spreads or back spreads. However, you want to call them.

The reason that we don't adjust these two strategies on the left-hand side you've got your debit spread, your typical call debit spread or put debit spread. On the right-hand side, we've got our ratio spreads. You can build this with calls or with puts.

The reason that we don't adjust these two strategies comes down to a couple of things. One, both of these are net buying strategies, so we don't even typically enter these strategies a lot, and when we do, we usually have a low probability of success getting into them which is why we mainly use them to hedge other positions and our portfolio.

In the case of a debit spread, which is the one on the left-hand side of your screen here, debit spreads are usually entered right around where the market is trading, so you buy one option in the money, sell one option out of the money.

Your break even point is right about where the market is, meaning that you have a 50/50 shot of making money on this so long term, without making any adjustments to this trade, we should expect that we should win half the time, lose half the time and not net any considerable gain.

That's why we don't use debit spreads as a course of regular business to generate income for our portfolio. We don't use those buying strategies. In the same sense, it's hard to adjust those positions because they're pretty fair, to begin with and you're going to use them more often to adjust or hedge a position that you have currently in your portfolio.

We might enter a call debit spread if we have too many bearish positions in our portfolio and try to rebalance ourselves out. If we lose on that trade or we win on that trade it's not going to create a huge difference in our income long term.

Generally speaking, debit spreads for us, again, are mainly used to hedge other positions, not really an income generating source. They are not the main way that we generate money trading. Same thing with ratio spreads.

Ratio spreads, if you think about it, you're buying two times as many or a factor of two times as many options than you're selling so you're getting long options which mean that implied volatility should be insanely low for your event to consider a strategy like that.

In the case that you enter a ration spread there are very few things that you can do to adjust that trade. Again, I'm not saying that you can't adjust these, I'm saying that we don't typically adjust them because one, we don't enter them all too often and two when we do enter them, we're usually doing so to adjust or hedge other positions.

Meaning we don't need to adjust that individual strategy itself. Ratio spreads, as I said, are long options, so you're either going to be bullish or bearish in your overall assumption. Again, you're not going to want to typically adjust that type of trade because you should be making it when the market is at some real high extreme or some real low extreme.

At the end of the day, we kind of think that adjusting these two strategies is like picking up pennies in front of a steamroller. It comes down to the fact that you're going to waste a lot of your time trying to fiddle around with these strategies that as their basic core root do not work out as a means to generate income.

By adjusting something that really shouldn't be a big part of your portfolio anyway, or the core part of your portfolio and how you generate income with options, it's going to be a lot of work for not a lot of payoff at the end of the day.

Again, to recap, these are trades for us that first, we don't often enter because of edge. Like I said, we're not going to be net buyers of options more often than we're not sellers.

We will always be, by the vast majority of the time, net option sellers than net option buyers so whenever we do get into these, we can obviously use these as a means for adjusting or hedging other trades in our portfolio, not as the core basis for our trading.

Second, we can easily control these positions on the entry by position sizing, meaning keeping our position size really small. If we ever do a net buying strategy, it will never be at the higher end of our allocation scale which is one to five percent.

It will always be on the very very low end, 1% or less for net buying strategies, again because we don't have the edge, we don't have the statistical edge in our favor as a net option buyer, so we can't do those trades large, to begin with. Therefore they shouldn't take up a lot of our time as we're trying to make adjustments.

For the rest of Track three, we'll assume that whenever we talk about adjustments strategies and techniques that we're not including debit spreads and ratio spreads in that conversation.

Again, this is not to say that you can't make adjustments to these, there are techniques by which you can make adjustments to debit spreads and ratio spreads that are out there.

We just assume that most of the time, 95% of the time that you're trading, they're going to be net sellers of options and those are the positions that you want to focus on, they're going to be a bigger portion of your portfolio, they're going to be the core strategies that generate income.

Ratio spreads and debit spreads are going to be a very very small part of your portfolio, if at all part of your portfolio. Therefore, to more easily focus on the other things and use your time wisely, be as efficient as possible. We just don't adjust them all too often.

Thank you so much for checking out this video. Hopefully, it was helpful. If you have any comments or feedback, please let me know, ask them in the comment box right below. If you love this video, thought it was helpful, please share it online. Help the spread the word about what we're trying to do here at Option Alpha.

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