Closing a Bear Call Spread

Posted by th961605 on November 29, 2011 (11:23AM)

I'm fairly new to credit spreads, and had a question about closing out a bear call spread. I placed a contingent order to sell the spread if the underlying reached my break even price (no problem setting this up) but what do I select in terms of price for the option? There is an "even" option and credit and debit options, but how do these prices affect my contingent order of the underlying reaching my break even? Thanks!

Posted by Paul McGhee on November 29, 2011 (03:03PM)

Since theoretical option prices are the result of (at least) four different variables simultaneously, I'm not sure how you'd determine a correct debit to close.

If you are trading in options with tight bid-ask spreads, I think all you could do would be a market order.

Me, I just watch the things like a hawk.

Posted by NYSEguy on November 29, 2011 (09:08PM)


th961605 said: I'm fairly new to credit spreads, and had a question about closing out a bear call spread. I placed a contingent order to sell the spread if the underlying reached my break even price (no problem setting this up) but what do I select in terms of price for the option? There is an "even" option and credit and debit options, but how do these prices affect my contingent order of the underlying reaching my break even? Thanks!


th,

Your bear call spread is a short position; you sold it to open, and you'll buy it to close.  If you want to break even on the spread (or buy it back at a predetermined profit target), you need only submit a limit order for the appropriate debit.  No contingent order is necessary.

Usually, when we consider a "break-even" underlying price for the spread, we do so in the context of the spread's expiration.  If you're planning to let the options expire, then you don't need to submit an order to close.  But if you want to exit the position before expiration, your order to close won't be contingent on the underlying's price.

Hope this helps.


Posted by th961605 on November 30, 2011 (11:29AM)

So would this be set up as a stop limit? Thanks for the responses!

Posted by optionsguy on November 30, 2011 (02:13PM)

th961605 said: I'm fairly new to credit spreads, and had a question about closing out a bear call spread. I placed a contingent order to sell the spread if the underlying reached my break even price (no problem setting this up) but what do I select in terms of price for the option? There is an "even" option and credit and debit options, but how do these prices affect my contingent order of the underlying reaching my break even? Thanks!

Hello th961605,

I think I may need a little more information from you to answer your question. Are you trying to place a protective "stop-loss" order on your credit spread? An example maybe when you initially sold to open the spread you received $1.50 credit to the account. So you are hoping to buy to close the position for less than $1.50 debit to the account, hence making a profit on the trade. If the market goes against the position it will trade at a higher debit than $1.50 to buy to close. A "stop-loss" type trade would be to say "if the net debit to buy the spread back to close the position is higher than $2.50 (for example) I would like to send an order market a trade to close this spread". Now hopefully you would close the spread close to the $2.50 price and then you would only lose the difference between $2.50 - $1.50 or $1 plus all commission charged for the transactions.

So if that is what you are looking for you are in luck. I just published a blog explaining how to enter this type of trade using the TK contingent order feature. The example used in the blog is for a debit spread, but the concepts is the same - just upside down if you will.

http://community.tradeking.com/members/optionsguy/blogs/92097-placing-contingent-stop-orders-on-spreads

If this is not the case let me know and I will try to better answer your question.

FYI... Any discussion on contingent or stop orders isn’t complete without mentioning this caveat: they do not provide much protection if the market is closed or trading is halted during the day. It the stock gaps the downside "protective" order will most likely trigger, but who knows what the next available price will be. The only true day and night protect is to use other options positions to hedge and design strategies where the risk is limited and known from the get-go. Please read the full terms and disclosures when using Advanced Orders.

Regards,

Brian (Og)

Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies.

Posted by HomeBrewer on November 30, 2011 (02:49PM)


Brian, as usual, gave a great explanation.  I'm also happy to see that TK now has a stop-loss available for multi-option trades!

One important item to consider, which I ran into trading credit spreads (the hard way), was: if you hold near expiration, and the stock is near your short strike, you may have a tough time closing the position out entirely.  What I mean is that normally you would prefer to BUY TO CLOSE the short leg and SELL TO CLOSE the long leg in one trade; I've seen that, near expiration, your long leg (usually much farther out of the money) will likely have very little liquidity left; so, the only way you could close the position would be to close the short leg only.

Good luck, and remember to set your entry and exit criteria BEFORE you enter the trade, and STICK TO IT!

Posted by th961605 on November 30, 2011 (03:07PM)

Great info. Thanks guys! 

Brian: Yes, I'm looking to place a stop limit here.

Homebrewer: Are you suggesting that I should place a stop-loss for the short strike only? Will the stopp-loss order fill if the long call can't be filled, or will this hold up the entire stop-loss? Also, I'm selling well OTM spreads here, but how do I go about setting up a stop-loss before I even place the order? Thanks again!

Todd

Posted by HomeBrewer on November 30, 2011 (03:27PM)


th,

I'm with Paul in this camp - I typically just watch things like a hawk.  It depends on how long you intend to hold the position; if you're very close to expiration you run the risk of not being able to close out the position because the long call can't be filled.  I've even attempted a 'market' close of my spread before, and couldn't get it filled.

If you want to use a stop-loss, I'd recommend doing the whole spread (unless you're trading very close to expiration).

I don't think you can do enter a stop-loss without having the underlying.

Hope that helps.

Posted by th961605 on November 30, 2011 (03:47PM)

So I would want to trigger with the "less credit/more debit" of my stop-loss debit price then, correct? Brian, I know you mention basing this on the net quote's midpoint.

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