Skip to main content
Track Risk-reward ratio
27 / 27
Search the archiveLibrary
Library

2020issue C1216-19

Bounding a short-dated option spread with a stop, a gap remainder, and a credit exit

In a historical worked example, a short-dated option spread was read from underlying price and days remaining before entry. The same stop price implied different dollar losses by time left, a gap through the stop could exceed those losses, and some holders used a stated fraction of maximum credit as an early exit.

  • In the worked example, a stop at 73.50 implied a loss of roughly 62 if hit immediately and roughly 19 if hit on expiration day.
  • A gap through the stop could exceed either stop-path loss, up to a stated maximum of 169 per one-lot. The worst-case remainder required a gap below 72, past the 73.50 stop.
  • If the underlying stayed above 74 through expiration, the stated credit on the example spread was 31.
  • Some holders planned to stay until expiration, while others treated 50 percent to 80 percent of maximum credit as an early exit. In one path, two sessions before expiration the open credit was 25, equal to 80 percent of the 31 maximum.
Entries in this reading3 entries
Current trackRisk-reward ratio78 readingsOption spread138 readingsStop-loss order297 readings

A pre-trade reading of the spread

An option spread is a defined set of option legs whose dollar outcome can be read from underlying price and days remaining before the trade is placed. The archive example used that reading as the working picture of the position.

The example risk diagram plotted dollar outcome against both underlying price and days remaining, with one curve for the first day and another for expiration.

The same stop price, two dollar losses

A stop-loss is a precommitted underlying price used to close the spread so a planned loss is bounded when that price trades without a gap. In the worked example, a stop at 73.50 implied a loss of roughly 62 if hit immediately and roughly 19 if hit on expiration day.

When a gap consumes more than the stop

Gap-through-risk is the extra loss that appears when the underlying jumps past the stop and the close occurs only after a worse fill, up to the spread’s maximum debit. A gap through the stop could exceed either stop-path loss, up to a stated maximum of 169 per one-lot.

The worst-case remainder in the example required a gap below 72, past the 73.50 stop.

Stated credit against both loss figures

Risk-reward-ratio is the comparison of stated credit if a favorable price holds through expiration against the stop-path loss and the larger gap-through remainder. If the underlying stayed above 74 through expiration, the stated credit on the example spread was 31.

Credit-harvest is an optional early close once a stated fraction of maximum credit is already in hand, used to drop remaining time risk before expiration. Some holders planned to stay until expiration, while others treated 50 percent to 80 percent of maximum credit as an early exit.

In one path, two sessions before expiration the open credit was 25, equal to 80 percent of the 31 maximum.

AMD $73.50 stop: dollar loss by time left, plus gap remainder

The same $73.50 stop on the short-dated AMD spread is not one dollar number. Immediate hit is about −$62, expiration-day hit about −$19, and a gap through $72 can run to the −$169 maximum. Those three stated losses are the pre-trade bound; some holders also took 80% of the $31 credit ($25) as an early exit rather than leave path risk on the table. Numbers come from the article’s worked example, not from digitizing a curve.
The same $73.50 stop on the short-dated AMD spread is not one dollar number. Immediate hit is about −$62, expiration-day hit about −$19, and a gap through $72 can run to the −$169 maximum. Those three stated losses are the pre-trade bound; some holders also took 80% of the $31 credit ($25) as an early exit rather than leave path risk on the table. Numbers come from the article’s worked example, not from digitizing a curve.AMD · short-dated weekly options, stop read immediately versus expiration day

Barring a gap, the stop at $73.50 is the planned exit. The −$169 figure is the stated maximum if AMD gaps below $72. Profit-side example: $25 open profit equals 80% of the $31 maximum credit.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
27 of 27 in the Risk-reward ratio track
1989Track finished · Next track: Scale-out position reductionOne add option sizing with a scale-out and a trail36 readings
All readings on this track · 27 readings
  1. 1987Precommit the stop and require a surplus payoff
  2. 1987When open losses overwrite precommitted exit rules
  3. 1991Ranking month-end holds with risk-reward and stops
  4. 1994Evaluating percentage profit exits on trend-following averages
  5. 2001Construct reward to risk before entry
  6. 2003A pre-trade readiness checklist for entry, abstention, and risk
  7. 2003Evaluating out-of-the-money strikes with saddle premiums and implied volatility
  8. 2004A critique of one-procedure trading decisions
  9. 2004Mechanical stops leak intent and misprice losses
  10. 2004Implied-volatility premium on rate indexes
  11. 2006Keep the stop that authorized the entry
  12. 2006Bound the loss with a risk-to-reward filter before entry
  13. 2007Audit the operator before abandoning a system
  14. 2007Failed-break slingshot reversal rules
  15. 2007A system-management template that sets the stop and the required reward before entry
  16. 2007Construct a pre-trade style envelope for entries and skips
  17. 2008Systems that skip the three decision gates
  18. 2010Four-gate veto before trend entries
  19. 2012Construct a trading plan as one written procedure
  20. 2012Forex stops and reward targets by quote increment
  21. 2013The average directional index as a lookback cluster and a risk-reward bound
  22. 2014A three-step worksheet for VIX futures tick value and low-vol risk-reward
  23. 2014Binary option premia, fees, and pre-expiry risk-reward
  24. 2015Selling far out-of-the-money commodity option premium as a forgiving timing case
  25. 2016Prepaid option spreads that bound range-day risk and reward
  26. 2016Pre-trade risk-reward versus instinctive exits
  27. 2020Bounding a short-dated option spread with a stop, a gap remainder, and a credit exit
By fieldOptions and volatility435 readingsBy year2020165 readings
All 78 readings tagged Risk-reward ratio
Also on Risk-reward ratio5 readings
2001Constructing vertical debit spreads with a preset risk-reward filter2010Constructing directional out-of-the-money butterfly spreads2010Vertical construction as a bounded-risk procedure2016Prepaid option spreads that bound range-day risk and reward1987Precommit the stop and require a surplus payoff