Hey r/options. I've been thinking more about trade structuring and position sizing lately. I wanted to discuss the simple debit spread, and how it relates to how I'm getting back into trading directionally again.
**The Trade**
Debit spreads are simple, what I'm saying isn't new news. I'm taking ATM 5 wide call or put debit spreads to express directional bias, risking $250 to make $250 as I continue building my methods. My system has other rules, entry and exit criteria, risk/edge management and tracking, etc. But that's not the point of the post.
**Two Observations**
**1. Debit spreads can be incredibly capital efficient in terms of leverage.**
I was monitoring some positions in my brokerage platform (Tasty) and the beta weighted delta (a measure basically weighting portfolio exposure to the S&P) is quite high relative to buying power.
https://preview.redd.it/dtubcrfcyzih1.png?width=948&format=png&auto=webp&s=54543d49b0cda6271ce9edea72003d94eb7245e5
This SPCX vertical call spread has a beta weighted delta of 3.14, or a SPY equivalent nominal exposure (at current $772.63 price) of \~$2426. We are controlling this position, with no chance of outsized loss, gap risk, etc mind you, with $245 of buying power. This is an effective **leverage of roughly 10:1.** This number is extreme in this case, but even this boring short PDS on Whirlpool appliances (not exactly a high flying vol stock) is giving us $857.61 of equivalent SPY (in this case negative) exposure for $137 in buying power, for a leverage of 6.25 or so.
By contrast, most brokers will give you something like 2:1 leverage on stock positions, perhaps higher if you have more capital or a prime broker etc.
https://preview.redd.it/h04jx2y900jh1.png?width=1633&format=png&auto=webp&s=cd150808f92796c5c8006ca35fec0d999d88b35e
What this should NOT mean, in my opinion, is that we size these up hugely and lever our whole account 10:1. That's obviously silly. The idea here would be to deploy a much smaller % of the account, keeping another portion in cash or a less risky asset, in order to get returns with less (and truly capped) drawdown risk.
**2. Defined Risk By Nature**
Because debit spreads are **defined risk by nature**, we are NOT exposed to the typical forces and pitfalls which often fell levered traders/positions (blowing through stops, huge gaps against us causing bigger than intended losses, low liquidity making exiting at stop impossible etc). As long as we size the position appropriately on entry (using some method, either kelly sizing or a fixed, small % of account equity to be conservative), we can experience the **benefits of leverage on the underlying with structurally limited per trade risk**. Because we're in a spread trade as well, we lose much less to theta, meaning we don't have to be right as immediately as we would with naked purchased directional options.
Structurally and psychologically, this structure can also provide a type of peace of mind that other types of trading and position expression cannot. At any point, you can have a truly capped sense of max account drawdown. You can have confidence that following a position sizing rule, no single trade is ever going to be able to blow you up. This confidence and security can lead to better ability to realize edge of strategy over time.
Again, **I know debit spreads have no edge alone.** Just wondering if anyone else has considered the above in terms of strong leverage + structurally capped risk with fewer tradeoffs which also encourages good position sizing and trading habits.