Ratio Back Spread - RISKLESS TRADE???

B

benysl

ES 1313
buy 1 1310 put -15
sell 3 1255 put for (+5.5 each) collected +16.5
Net currently is +1.5 points

Sell stop on Futures 2 lot at 1255.
If futures trade to 1255 my 1310 put will be +55 points in the money.

Buy 2 Call at 1255 for protection (25 points each) ended up -50points

If market expire above 1310 - +1.5 points in premium

If market expire at 1254 not triggering my futures sell stop - maximum profit. Put from 1310 - 1254. (+56 points and earlier +1.5 points)

If market close at 1200. My 2 call at 1255 expire worthless. My put 1310 is in money and my 2 futures is in money. Able to offset the 3 put i sold at 1255.

If market hit 1255 triggering my futures and activated me to long 2 lot at 1255 call. Market than traded back to 1300. My 2 call make money and my 1310 put make money.


Minimum profit +1.5 points in
Maximum profit (got to do some calulation)

Riskless trade????
 
At 1255, what you are doing is buying back two at the money puts (short future+long call=long synthetic put), and making a loss on these 2 puts-unless they are bought back for less than 5.5. You end up with the put vertical 1310-1255, which has made money, but not necessarily enough to cover your loss.
 
Riskless? Heck no! You're assuming that the market will conform to your expectations. If the S&P quickly drops from ~1300 to ~1255, you're going to simultaneously projectile vomit and have nasty squirts which will paralyze you. The implied volatility on the short-puts WILL skyrocket and throw your account into a loss. In a meltdown scenario, the resting order to initiate the short futures "hedge" would probably get filled at a much lower price and the call purchase WILL be more expensive than you imagine. Another thing, your nomenclature is wrong. The position you started with, long-1 and short-3, is a "ratio put spread". The guy taking the other side has a "put backspread". Instead of adding on to the position with those different "hedges", reduce and offset instead. You're only making a bad trade worse by attempting to trade around it.
 
Quote from kalashnicac:

At 1255, what you are doing is buying back two at the money puts (short future+long call=long synthetic put), and making a loss on these 2 puts-unless they are bought back for less than 5.5. You end up with the put vertical 1310-1255, which has made money, but not necessarily enough to cover your loss.
More...
Good analysis. Obviously, it's not a riskless trade.

To give an example, using benysl's estimate for the two 1255 synthetic puts of 25 each he has effectively bought back his original 1255 short puts for 50 when his original credit was 11, loss of 39.

Therefore, his remaining bear put vertical spread has to finish 39 points in the money just to break even. If the bear spread finishes OTM his max loss is 39. If the bear spread achieves the full spread of 55 he has a 16 profit.

Of course, the actual cost of the two synthetic puts may be different than benysl's estimate and that would change the P/L analysis above. In any case, it's clearly not a riskless trade.

Also, the above assumes the scenario of ES falling to 1255. If ES doesn't fall to 1255 then he pockets the original 1.5.


Don
 
benysl,

Nice analysis! There are basically three risks associated with this trade.

1) Market may go down(gap down) so fast that you can't hedge your trade properly with futures at 1255. (think of 9/11)

2) Volatility may go up so high at 1255 to make the 2 calls cost more than 25 each.

3) Expiration risk: That is if your puts/calls and futures have different expiration month. (no risk if they all expiration on same month)


Oh, and you're forgetting to include the premium you're going to collect from shorting the futures in your calculation.
 
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