Saturday, November 12, 2011

The Spreading Tactics

I strongly suggest using spread orders to enter and exit spread positions, since the advent of the internet, and usually don’t use spread orders but rather leg in and leg out of positions. In other words, will execute one side of the spread first and then the other side. This practice ensures an execution of the spread and, if done right, usually at a better price than a spread

However, there is always the risk of losing control of the spread and taking a big loss. Therefore, legging into and out of a spread should be avoided in a fast moving market. Nevertheless, with the speed and immediate feedback possible on the internet, such spreading tactics can work very well.

Here is how to enter such trades. Let’s say that you want to enter XY debit spread where you buy XY April 50 call priced at 2–2.5 and sell the XY April 55 call priced at 1–1.25 Usually you enter the buy side of the trade first so you are not naked at any time. You first would enter an order to buy the XY Apr. 50 call at 2.25.

Give it a few minutes, and if the order has not been filled, move the limit to the asked price of 2.50. Enter the second order to sell the XY Apr. 55 call. First enter an order to sell at 1.12 between 1 and 1.25, but then immediately change it to a market order. Your danger, here, is that XY might move against you before you can get the second leg of the trade off.

So, again, avoid fast moving markets. Spread orders are always the safer way to go, but if you use spread orders, always use a limit order.

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