39 lines
3.0 KiB
Plaintext
39 lines
3.0 KiB
Plaintext
690 Part V: Index Options and Futures
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WHICH STRATEGY TO USE
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The profit potential of the put backspread is obviously far different from that of the
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call ratio spread. They are similar in that they both offer the strategist the opportu
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nity to benefit from spreading mispriced options. Choosing which one to implement
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(assuming liquidity in both the puts and calls) may be helped by examining the tech
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nical picture ( chart) of the futures contract. Recall that futures traders are often more
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technically oriented than stock traders, so it pays to be aware of basic chart patterns,
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because others are watching them as well. If enough people see the same thing and
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act on it, the chart pattern will be correct, if only from a "self-fulfilling prophecy"
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viewpoint if nothing else.
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Consequently, if the futures are locked in a (smooth) downtrend, the put strat
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egy is the strategy of choice because it offers the best downside profit. Conversely, if
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the futures are in a smooth uptrend, the call strategy is best.
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The worst result will be achieved if the strategist has established the call ratio
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spread, and the futures have an explosive rally. In certain cases, very bullish rumors
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- weather predictions such as drought or El Nifio, foreign labor unrest in the fields
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or mines, Russian buying of grain - will produce this mispricing phenomenon. The
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strategist should be leery of using the call ratio spread strategy in such situations,
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even though the out-of-the-money calls look and are ridiculously expensive. If the
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rumors prove true, or if there are too many shorts being squeezed, the futures can
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move too far, too fast and seriously hurt the spreader who has the ratio call spread in
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place. His margin requirements will escalate quickly as tl1e futures price moves high
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er. The option premiums will remain high or possibly even expand if the futures rally
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quickly, thereby overriding the potential benefit of time decay. Moreover, if the fun
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damentals change immediately - it rains; the strike is settled; no grain credits are
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offered to the Russians - or rumors prove false, the futures can come crashing back
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down in a hurry.
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Consequently, if rumors of fundamentals have introduced volatility in the
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futures rnarket, implement the strategy with the put backspread. The put backspread
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is geared to taking advantage of volatility, and this fundamental situation as described
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is certainly volatile. It may seem that because the market is exploding to the upside,
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it is a waste of time to establish the put spread. Still, it is the wisest choice in a volatile
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market, and there is always the chance that an explosive advance can turn into a quick
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decline, especially when the advance is based on rumors or fundamentals that could
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change overnight.
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There are a few "don'ts" associated with the ratio call spread. Do not be tempt
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ed to use the ratio spread strategy in volatile situations such as those just described;
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it works best in a slowly rising market. Also, do not implement the ratio spread with |