A Back-Spread Strategy For A Big Breakdown
Major indices continue to be locked in a range as we await the outcome of the debt ceiling negotiations.
The maneuvering reminds me of the old Mad Magazine SPY vs. SPY comic strip, in which bulls and bears try to out-smart each other, projecting out three steps ahead only to see it all backfire and blow up in both their faces.
Anyway, it seems no one wants to get short or sell ahead of the debt ceiling—which everyone thinks will get resolved one way or another—causing the market to rip higher.
At which point, people will come in and sell the news.
I suppose they can both be right and if you’re nimble enough might be able to catch all the moves.
I won’t try to be that cute and catch both sides… Yet.
What Options360 did today is establish a bearish position on the SPDR S&P 500 ETF (SPY) that will benefit from a short-term market puke, which may be needed to get politicians to do something.
The strategy I employed is referred to as a “Back-spread”, a form of a ratio spread, which buys a greater number of contracts then it sells, thus it is a covered position.
For example a put-back spread is constructed by selling (writing) fewer put options on an underlying security than are bought. A trader will typically sell a closer -to-the money put option and use the proceeds to buy multiple put options on the same security, but with a further out-of-the-money strike.
A put back-spread is a bearish trading strategy that seeks to gain from a sharp decline in the underlying security. A sharp sell-off would also be accompanied by an increase in implied volatility that would also benefit the position as the ratio (long 2 vs. short 1 contract) has a positive gamma; meaning as price declines and IV jumps profits accelerate.
I put one more twist on the back-spread by adding time or calendar elements. This will give my Options 360 students and I the flexibility to “roll,” reducing the cost basis/risk.
Here is the risk reward profile of the trade Options 360 students establish today which consists of:
-Buy to open 2 contracts June (6/2) 415 Puts
-Sell to open 1 contract May (5/25) 417 Put
For a Net Debit of $3.95 (+/-0.05)
This is $395 total cost for the 2×1 spread.
You can see the further the SPY declines the greater the profits. More importantly, the risk is limited to the cost, in this case $390 for a 2×1 position.
The profit is (theoretically) unlimited, however, my target is for SPY to move below $410 by next week, which would deliver approximately a 65%+ gain depending on timing and adjustments.
These are the type of opportunistic options trades and flexible strategies that have helped Options 360 deliver an average 47% annual return for the past 8 years.
If you find yourself interested in learning more about me and my method of teaching even the most novice traders how to trade options, check out this presentation I put together to get filled in. This link will take you directly to my Options 360 presentation.
If you’re interested in joining Options 360 and getting in on all the action, you can follow this link to get signed up today! I look forward to trading with you.
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