26 lines
1.7 KiB
Plaintext
26 lines
1.7 KiB
Plaintext
Ratio Vertical Example
|
||
Let’s examine a trade of 20 contracts by 40 contracts. Exhibit 16.5 shows
|
||
the greeks for this ratio vertical.
|
||
EXHIBIT 16.5 Short ratio vertical spread greeks.
|
||
Before we get down to the nitty-gritty of the mechanics and management
|
||
of this trade—the how—let’s first look at the motivations for putting the
|
||
trade on—the why. For the cost of 1.00 per spread, this trader gets a
|
||
leveraged position if the stock rises moderately. The profits max out with
|
||
the stock at the short-strike target price—$75—at expiration.
|
||
Another possible profit engine is IV. Because of negative vega, there is
|
||
the chance of taking a quick profit if IV falls in the interim. But short-term
|
||
losses are possible, too. IV can rise, or negative gamma can hurt the trader.
|
||
Ultimately, having naked calls makes this trade not very bullish. A big
|
||
move north can really hurt.
|
||
Basically, this is a delta-neutral-type short-volatility play that wins the
|
||
most if the stock is at $75 at expiration. One would think about making this
|
||
trade if the mechanics fit the forecast. If this trader were a more bullish than
|
||
indicated by the profit and loss diagram, a more-balanced bull call spread
|
||
would be a better strategy, eliminating the unlimited upside risk. If upside
|
||
risk were acceptable, this trader could get more aggressive by trading the
|
||
spread one-by-three. That would result in a credit of 0.05 per spread. There
|
||
would then be no ultimate risk below $70 but rather a 0.05 gain. With
|
||
double the naked calls, however, there would be double punishment if the
|
||
stock rallied strongly beyond the upside breakeven.
|
||
Ultimately, mastering options is not about mastering specific strategies.
|
||
It’s about having a thorough enough understanding of the instrument to be |