Back/Ratio call/put spread strategy

S

stockspy456

I have recently decided to
backtest this strategy, and so far, it appears to perhaps be the best all around strategy for my day trading SPX options.

It requires an idea, or best guess, as to which direction you see the market heading.

Bullish - Sell 1 lesser strike Call + Buy 2 greater strike call

Bearish - Sell 1 greater strike Put + Buy 2 lesser strike Put

I believe I've read that this works best in high volatility, but I'm discovering that it's still appearing to be "not a bad choice" when volatility isn't so high.

I have backtested it a few times, comparing to long straddles (both bullish and bearish long straddles). It seems that the back/ratio is fairly reliable if you are picking a direction, while a straddle can sometimes only barely go positive even with a few points movement in the SPX.

For day trading specifically, this also seems like a decent way to hedge my trade so that if the market does exactly opposite what I was predicting, I won't be completely broken, and even better, plenty of time to close this position if I do feel the market is making a switch. It also removes a good amount of "frantic" feeling that I sometimes get in high fluctuations.

Since I've only backtested this on a few days (planning to backtest on a variety of different days), I just wanted to throw this out here to see if anyone else may have tried this and what their findings were in regards to the strategy as a whole, as well as if anyone has considered this as a better strategy to handle some of the risk of the market pulling a 360 on you versus straddles or simply buying one direction.
 
stockspy456 said:
Bullish - Sell 1 lesser strike Call + Buy 2 greater strike call
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Backspreads can be a pretty good hedge of vol/ large move down bet. With the way the skew works in the indices though, I have never been able to make a backspread work on the call side. Unless it is a very large move up, your longs just don't make enough to cover the loss on your short. In fact, I find that the opposite on the call side (by 1 sell 2 further out hedge with another to make it a broken wing fly if you want) seems to have more success.
 
Day trading a ratio spread means you have a lot of commissions and SPX wide b/a spreads to deal with. Cannot see how you can scalp using a ratio spread. Good strat for longer term plays or vol plays.
 
optioncoach said:
Day trading a ratio spread means you have a lot of commissions and SPX wide b/a spreads to deal with. Cannot see how you can scalp using a ratio spread. Good strat for longer term plays or vol plays.
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Right. When I say day trading, what I mainly mean is opening my position in the morning, and closing ether once the index reached its range, or close at market close. Basically just not holding overnight. Today for example, I only did 4 transactions.
 
Dolemite said:
Backspreads can be a pretty good hedge of vol/ large move down bet. With the way the skew works in the indices though, I have never been able to make a backspread work on the call side. Unless it is a very large move up, your longs just don't make enough to cover the loss on your short. In fact, I find that the opposite on the call side (by 1 sell 2 further out hedge with another to make it a broken wing fly if you want) seems to have more success.
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Actually I've found the call side to work fine. You would only pick the call side if you see the index being greater than what it's at when you purchase (aka, you think it's headed up). Picking the correct combination of strikes is very important though. This morning for example, I did the attached back/ratio purchased for $8.5 debit, which yielded a $1.9k profit when I closed for $14.5 credit. It went higher during the rest of the day. The index was around 2133 when this order was filled this morning. When I closed, the market was around 2143, so a 10 point move. Picking a higher combination of strikes would require more of a move, or at least more volatility, I believe.

But since volatility was decreasing all day today, I would have been better off with a bullish straddle, most likely. Still nice that the back/ratio is effective in low volatility environments, though much less effective.
 

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Also, when I did this spread this morning, volatility on both sides were about the same, so going with a 1:2 ratio was what I chose to do, basically hedging half the risk if the market pulled a fast reversal and never retraced back. If volatility wasn't equal on both sides, I believe I would need to basically set my ratio up to reflect the difference in volatility, if I wanted to hedge roughly half the risk. Need to try this more.
 
stockspy456 said:
Right. When I say day trading, what I mainly mean is opening my position in the morning, and closing ether once the index reached its range, or close at market close. Basically just not holding overnight. Today for example, I only did 4 transactions.
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Opening and closing the position in the same day is... day trading. What you said is not any different that what I criticized this strategy for. Just because an index moves the right way does not mean a ratio spread with calls loaded with time value premium or vol (same thing in some ways) is going to be profitable for an intraday scalp.
 
optioncoach said:
Opening and closing the position in the same day is... day trading. What you said is not any different that what I criticized this strategy for. Just because an index moves the right way does not mean a ratio spread with calls loaded with time value premium or vol (same thing in some ways) is going to be profitable for an intraday scalp.
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Understood. I'm partially using it as a way to buy myself time in making a decision to close my position (aka impulses). Since this strategy will manage some of the risk, and give me a "little" peace of mind. Though I did experience today a profit of $1.9k, and after the $35 fees and any small interest rate charged for margin that might be used.

I suppose my goal is to make a profit, in a "safer" way than simply buying a single direction. These types of "safer" approaches require more cash, and profit less, but if I'm able to reach my profit goal even by fronting a lot, then that's fine with me.

That makes me think, what could be the absolutele safest strategy if specifically looking at spx option trading. If I wanted to receive "x" profit a week, and I have "x" dollars to use, what could I do. Of course, whatever it might be, the return would be a tiny fraction of buying momentum swings, but there would be dramatically less risk. Pretty much get profit for putting your money in the market, but requiring that it's liquid and not locked up in a IRA or something. I can't do naked calls and collect theta but that would be one example of basically getting profit for the market simply moving sideways. Perhaps another topic, but I'm all ears for any comments on that within this thread too! Even if just guiding me to reading material :-)
 
Puts are definitely less forgiving it has seemed like. That's why doing a back/ratio where you are both long and short, works effectively, especially when volatility is high. If the skew really flattens, I would hope I would already be out of that position and into one that takes advantage of low volatility. Straddles seem more effective when volatility is low.
 
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