Options Corner
Now, what I am looking for is either a volatility spike (perhaps on euro issues) or a decline in the market that pumps the cost of the Feb 5000 Puts up to say 120. If this were to occur (ideally both), then I would sell a further £20 of this strike and so haul in a further £2,400. Net cost to me for the strategy is, in fact, actually a credit of £900 overall (£1500 minus £2400). What I have on is a position that will make money if the market declines towards 5250 as I am long £20 of the FTSE Feb 5250 Puts and short £30 of the Feb 5000 Puts. The total delta (sensitivity to market movement) is higher overall on the Feb 5250 Puts even though I am long only two thirds relative to the short 5000 Puts as the higher strike is closer to the money. Here’s the neat thing: if the market goes up, then I have received a net £900 and so I can leave the position to run. If the market goes sideways, again, I can leave the position and look to collect the net £900 at expiry. If the market goes down, then the position will begin to accrue a higher delta and thus will make money too. The reason the strategy works this way is contingent upon ‘legging’ into it with the initial decline that allows me to sell the lower strike for a higher premium. What I personally like to do, however, is if a number of weeks passes by and I am able to buy back the incremental short leg (i.e. the extra £10 in the example above) for equal to or less than the net credit I have received, then I definitely do this. The reason one is frequently able to do this is because of the concept of time decay — as time rolls on, premium gets cut (all other things being equal). The end result is that I am left straight with a straight Bear Put Spread for NIL cost, that’s right NIL cost! If the market should fall to 5000 or below, then the collect is £20 x £250 = £5,000.
68 | www.financial-spread-betting.com | September 2012
I have personally found that ‘time bombs’ work best when an index has been in a particular up or downtrend for a 12 - 18 months period of time, and where the deviation from the 28 week moving average is about 10-15% (the larger the better). What you do is incept the bought side of the strategy at this point and wait for the market to move 2-4% in your favour over as short a period as time as possible hopefully, then you sell the short leg on a 1:1 for basis for ideally a small debit. Should the market continue to move in your favour over successive weeks, you sell the second tranche of the short leg so that you are in on the strategy for a net credit. If you are playing the FTSE via this strategy, the ideal distance between the strikes is 250-300 points… It is important to remember the tweak to the strategy, and that is: if at any stage when you have got the ratio spread running you can buy back the ratio’d element of the short leg and get your strategy cost on the remaining simple Call (or Put spread) down to nil or perhaps 1 -4 points, you should ALWAYS do this. When you’re looking at a potential payout of 250-300 points whether you pay zero or 2, 3 points for this is simply irrelevant.