Tuesday, May 18, 2010

Ratios, Ratios, and more Ratios

Ratio spreads turned out to be the talk of the table during last week's Option's Action. Though cynics may sight their occasional misleading statements (as I've done before), they do a pretty good job of summing up various option strategies. This go around was no exception as their ratio spread summary was on point. They even touched on the potential drawbacks of shorting extra naked puts and encouraged traders to exercise caution when doing so.

Speaking of ratios, the SPY ratio spread mentioned in April's Volatility Spike and Ratio Spreads is coming right into make it or break it territory. The ideal profit zone for the May 1x3 117-113 put spread sits right around the $113 level making the obvious best case scenario a pin right at $113 going into expiration this Friday. Unfortunately with the type of volatility we're seeing play out day to day, this desirable outcome is far from a slam dunk. We've entered the final phase for May options where the two greek titans, Gamma and Theta, will commence duking it out. While our ally Theta's momentum has been building and he possesses the ability to deliver some serious profits over the next three days, Gamma isn't afraid to fight dirty. Don't forget his momentum has been surging as well, especially now that our short options are sitting at-the-money.

[Source: MachTrader]

While I'd like to say I'm fully vested in this play and ready to see it through to the end, truth is I bailed after the flash crash and subsequent snap back rally. Call me crazy, but that crash gave me the heebie jeebies and I considered myself lucky to get back close to even. Were I still in, I may attempt to hold out for a few more days to give Theta some rope. But if the market sell-off turns nasty I'll be quick on the exit trigger lest Gamma turn that rope into a noose.

For related posts, check out:
Gamma vs. Theta
Gamma vs. Theta Part II


MarkWolfinger said...

Hi Tyler,

"the obvious best case scenario a pin right at $113 going into expiration this Friday."

Are you seriously recommending that you let the Greeks fight it out - and hold onto this trade?

Isn't the risk far greater than the reward?

Hasn't this spread already earned enough profit? (This point is not important to me, but it is to most traders).

Just asking. Each trader finds his/her own comfort zone.


Tyler Craig said...

Good question Mark. I was simply making an observation that despite the "potential" gains that could be accumulated due to theta over the next few days, traders have a serious foe to deal with- Gamma. My point at the end of the post was to show that IF I were to hold any longer, I would keep it on a very tight leash and exit quickly if the market turned nasty.

I don't typically hold to expiration and am the type that exits when I've achieved a certain percentage of potential profit. I agree that the gamma risk outweighs the potential remaining reward.