2016issue C0228-31
Prepaid option spreads that bound range-day risk and reward
A 2014 range-session case restates how an option-spread can collect the prepaid-loss at entry and print a risk-reward-ratio on the ticket, then asks, as editorial, whether that bound interrupts the loop from a 30 percent drawdown to skipped setups and process failure.
- Five consecutive losing sessions at 100 of risk and three trades per day reduce a 5,000 account by 1,500, or 30 percent, which is the drawdown that can precede skipped first setups and a later stopped-out entry.
- A common response is to replace indicators and methodology, widen stops in a way that can enlarge later losses, or freeze and stop entering.
- On a defined-payoff option-spread the prepaid-loss is collected at entry, so the loss cannot later grow from a moved stop, a stop-jump, or a margin call.
- A ticket that shows 23.50 of maximum loss against 76.50 of maximum profit states a 1-to-3 risk-reward-ratio before the order is sent, and that reading is held for the life of the contract.
A losing streak, skipped setups, and wider stops
Five consecutive losing sessions at 100 of risk and three trades per day reduce a 5,000 account by 1,500, which is 30 percent.
After a drawdown, a trader may skip the first valid setups, watch price move without him, then enter a later setup that is still stopped out.
A common response to that sequence is to replace indicators and methodology, or to widen stops, which can enlarge later losses, or to freeze and stop entering altogether.
Prepaid-loss and remaining profit on the ticket
An option-spread is a short-dated, two-sided options structure whose debit or credit at entry fixes both remaining profit and maximum loss at expiration. The risk-reward-ratio is the prepaid maximum loss compared with remaining maximum profit, read from the ticket before the order is sent and held for the life of the contract.
If the contract settles at 100, a purchase at 85.75 prepays 85.75 of risk for 14.25 of remaining profit, while a sale that prepays 15 of risk leaves 85 of remaining profit.
An order ticket that shows 23.50 of maximum loss against 76.50 of maximum profit states a 1-to-3 risk-reward-ratio before the trade is placed.
The prepaid-loss is the full amount that can be lost on the contract, collected from the account at entry so the loss cannot later be enlarged. On a defined-payoff option-spread the full potential loss can be collected at entry, so the loss cannot later grow from a moved stop, a jumped stop, or a margin call.
A range-session on a yen pair
A range-session is a low-trend interval in which the working thesis is that price remains on one side of a strike until a nearby expiration.
On 4 June 2014 a yen pair sat at an average-true-range stop with no buying volume. A short-horizon option-spread treated 102.60 as a ceiling through a 57-minute expiration while price moved five ticks and stayed below that level.
On that same path the option-spread committed less capital than the compared spot or futures tickets, and unlike those linear positions its maximum loss could not increase if a volatility surge jumped a stop. A stop-jump is a price gap through a protective stop on a linear futures or spot position that leaves the loss larger than the planned stop distance.
Editorial reading of the bound
Editorial interpretation: the archive path shows a prepaid bound and a ceiling held through expiration. It does not show that the bound repairs skipped first setups, prevents a later stopped-out chase, or stops a trader from replacing the method.
Editorial interpretation: the procedure to test is whether a ticket that already states the prepaid-loss against remaining profit, such as 23.50 against 76.50, keeps the entry, the abstention, and the sized loss readable as one rule after a 30 percent account decline.
All readings on this track · 27 readings
- 1987Precommit the stop and require a surplus payoff
- 1987When open losses overwrite precommitted exit rules
- 1991Ranking month-end holds with risk-reward and stops
- 1994Evaluating percentage profit exits on trend-following averages
- 2001Construct reward to risk before entry
- 2003A pre-trade readiness checklist for entry, abstention, and risk
- 2003Evaluating out-of-the-money strikes with saddle premiums and implied volatility
- 2004A critique of one-procedure trading decisions
- 2004Mechanical stops leak intent and misprice losses
- 2004Implied-volatility premium on rate indexes
- 2006Keep the stop that authorized the entry
- 2006Bound the loss with a risk-to-reward filter before entry
- 2007Audit the operator before abandoning a system
- 2007Failed-break slingshot reversal rules
- 2007A system-management template that sets the stop and the required reward before entry
- 2007Construct a pre-trade style envelope for entries and skips
- 2008Systems that skip the three decision gates
- 2010Four-gate veto before trend entries
- 2012Construct a trading plan as one written procedure
- 2012Forex stops and reward targets by quote increment
- 2013The average directional index as a lookback cluster and a risk-reward bound
- 2014A three-step worksheet for VIX futures tick value and low-vol risk-reward
- 2014Binary option premia, fees, and pre-expiry risk-reward
- 2015Selling far out-of-the-money commodity option premium as a forgiving timing case
- 2016Prepaid option spreads that bound range-day risk and reward
- 2016Pre-trade risk-reward versus instinctive exits
- 2020Bounding a short-dated option spread with a stop, a gap remainder, and a credit exit