building ratio spreads

Ironplates

Ironplates

what is a good way to build these 1x2 backspreads?

what characteristic of the stock? high volatility, high historic vol?

what characteristic of the OTM calls? the delta, gamma, vega, theta, expiry, strike spread from the short call?

what characteristic of the Short call? high theta, high delta, shorter maturity, longer maturity to collect premia?

what kind of price action is this spread good for?

consolidation, expecting a break out

existing trend?

my understanding is that this spread buys 2x an OTM option and sells 1x an ITM option to net premium?

if the price action fails to move a good distance before the leg expiration, it would be a bad trade.
 
When you sell a NEAR (usually not in) the money call and buy 2 OTM calls you expect either the underlying to go down or to move strongly to the upside. Put it on perhaps prior to an earnings event where the stock may make that explosive move. IOW you WANT it to either move away or blow thru the short and farther than the longs. Last GOOG earnings would have made this a huge winner.

Flip the trade and buy a near the money (put or call) and sell 2 OTMs to pay for it and your expecting a move in your direction but not an explosive one.

The first example is just a credit spread with an extra + contract and usually plays for an increase in vol. Second example is an unfinished b-fly ( or a debt spread with a naked short) obviously the 2nd example is unlimited risk with a naked short while the 1st example is defined risk with perhaps unlimited potential gain. you might be expecting vol contraction on the second trade.

If it doesn't do what you want..think..or expect it to do then yes its a bad trade.
 
Quote from Martinghoul:

If you have a view on the dynamics of the skew. That's the way to use 'em, IMHO.
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please elaborate on this. is this about the dealing with statistical extremes relative price, the option, what?

the setups I use, are contraction that burst into expansion. the underlying trade will move one way or another, and fairly soon after enter.

see the WAB chart posted earlier.
 
Well, at any given time, skew has a particular shape (let's say it's very steep). If you believe that the shape of the skew that actually gets realized on a large move of the underlying is unlikely to be what the mkt prices, you can do ratio spreads or ladders or some such thing to express this view.
 
Ironplates said:
the setups I use, are contraction that burst into expansion. the underlying trade will move one way or another, and fairly soon after enter.
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Ratios are a directional play. It seems to me that if you expect an expansion in IV in the near future with a price move either up or down, a long straddle will be your best strategy. You could also do a short butterfly.
 
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