SPY Ratio Credit Spread

[Mikael 31]

Hey guys, I have done a few of these trades (very small allocations) recently and gotten pretty good results. Just wanted to share and hear about what you guys think.

 

So basically the idea is to buy and sell OTM puts or calls in a ratio which gives you credit.

 

For ex. a put credit ratio spread i was thinking about putting on is

 

Buy to open 1x  Aug 165 SPY Put 

Sell to open 8x Aug 155 SPY Put

0.3 Credits

 

If by expiration (Aug 17) SPY settles beyond 165 you get the keep the $30 credit per spread

 

BE is at 153.50, you take on unlimited loss beyond 153.50

 

Max profit is if SPY settles at 155 on expiration, which gives you about 3400% return on credit or about 50% on margin. Obviously that's very unlikely but you will start seeing profit if SPY drops to any point between 165 and 155.

 

You can adjust your ratio or strikes to take on more risk (and thus higher credit). 

 

Probability of SPY being below 155 by Aug is basically 0% according to ToS. 

 

Margin is a bit high on the trade so it's about 2k per spread. If you have portfolio margin it would be lower. 

 

If your bullish you can take on the opposite side (or even put on both side). Such as 

Buying 1X 175 call

Selling 8 X 180 call for 0.2 credit.

 

The thing i like about this type of trade is you can be wrong on direction and still make a profit. If you can sell enough OTM your downside is pretty much negligible. 

 

Only thing is you need a larger account because of the margin requirements.

 

What do you guys think? 

Edited July 22, 2013 by Mikael

[Mikael 31]

the reason the credit is so low right now it's because SPY on has been on a huge rally. If you do the trade on a down day you can get more credit.

 

you are also taking advantage of the volatility smirk on index options (OTM options have higher IV than ATM options).

 

bad thing is the return on margin on these type of trades are not great. But most of the time i have alot of free margin on the SO portfolio because we usually don't have 6 or 7 trades open at once. 

Edited July 21, 2013 by Mikael

[Mikael 31]

oh one more thing. a big risk is if the underlying gaps down alot (or the price drops like a rock very quickly) then it'd cost alot more to buy back the shorts. but the idea is to put these on for shorter time spans (in this case less than a month), so you can take advantage of the big theta on your shorts, and hopefully your long moves in the right direction.

 

also don't think the SPY will gap down alot unless there's a blackswan event or something.

[Hannes Kury 7]

Thanks for sharing, Mikael! The strategy looks attractive to me but that does not mean anything. One could classify it as ~ neutral which could make it a candidate for SO. I look forward to comments from Kim and the other very appreciated master members.

[Mikael 31]

yeah, i wanted to hear what other members thought as well. the main reason is the SO portolfio always have alot of margin available so you can use it this way. it's relatively safe and you can stand to make a good profit if your directional bet is right. If it's wrong... well you still get to keep the credit

[chanson 0]

The "unlimited loss below 153.50" on 7 SPY puts would keep me up at night. A small chance of a wipeout is still a risky trade.

[Yowster 8,022]

I've done some of these ratio put spreads successfully in the past - but I've only done them with 1x2's so the underlying stock has a ways to fall lower than your short strike before losses kick in.  If some market or other world event caused things to crash, you'd be out a lot of money given your 1x8 ratio.

 

I'd look for ways to lower the ratio in your trade.  For example, you can open the Aug 165/160put with a ratio of 1x3 and still collect a credit for opening the trade, and your break even will be about the same as with your 1x8 (slightly lower than 155).  This would also greatly lower your margin requirement. 

[Mikael 31]

Yes yowster you are right. The trades I have done are all selling way otm strikes to minimize chances of loss but I can see why the 1 to 3 ratio is better in case of a black swan event! Thanks.

Chanson you can always close the trade before it hits your BE. In fact that means you got the direction right. You just don't want the SPY to gap downwards 15 dollars then you would be in trouble.

[dbh21 62]

Your thesis with this trade is that you think the SPY is likely to go towards 155 right? You could trade a 150/155/160 butterfly for a 9 cent debit but that has protected downside.

 

Personally, I don't like unhedged trades unless its a wheel trade. Especially on the SPY since whenever I think it should go one way, it goes the other.