Monday, February 8, 2010

Put Ratio Spread Update

In Gaming the Selloff with Put Ratio Spreads, we reviewed a February 1x2 put ratio spread on the SPY. Fast forward 2 weeks, tack on a 2% drop in the SPY and a largely unchanged VIX and what do we have?

A profitable trade.... so far.

Though there are a lot of moving parts with ratio spreads, the gist was to profit from a mildly bearish move in the underlying as well as a decline in implied volatility. While we haven't had much of a decline in volatility, the two weeks of time decay and drop in price have helped the trade mature into a decent sized profit.


[Source: EduTrader]

Remember, the biggest profit zone resides between 104 and 98 at expiration. If you don't mind the gamma risk that is assuredly building as we approach expiration next Friday, you may consider holding a bit longer. With the SPY currently residing at $106.55, the trade is negative theta. In other words, if SPY sits tight and we fast forward to expiration, we will actually give back some of our profits due to time decay.

First person to answer in the comments section why the position is negative theta gets bragging rights:)

2 comments:

Jon & Gari said...

I'll take a shot at that one, Tyler. Your long option is closer to ATM,which has a different rate of time decay than the short options which are further OTM. As expiration draws nearer, the 104 put will have an increasing (nonlinear) theta whereas the 101 puts will have a more steady rate.
Jon

Tyler Craig said...

Jon,

Nice- you pretty much nailed it. At this point in the trade, the long option has more extrinsic value than both short options. Thus we have more premium to lose than gain between now and expiration. At trade inception it was the opposite as the two short options had more extrinsic value.

Kudos-