Reverse Ratio Calendar Spreads?

D

darp

I have just signed up for Elite, first post. Have seen the posts before doing searches on yahoo for option strategies and am very impressed with knowledge level here. Several greek masters post.

Figured hey its worth paying for. Then found out its free when signed up :-) What a deal.

On calendar spreads the odds are on your side, but if it goes strongly into the money it will lose if you are 1 to 1 ratio wise. But lets say xyz is 50 and May 50c is 2 and Aug50c is 3.5 if xyz sits ends up at 50 May end you should have nice profit.

But if its 57 then the May would be $7 and Aug maybe 8 and you have a $1.50 loss X 10 =$1500

But if you bot 10 and sold 8 the loss would only be -$600 which would be easy to get back selling 10 July 50c for 7.80 lets say. Thus $800 additional premium would be taken in with zero risk as both same strike and you end up with a $200 profit overall at the end of July minimum.

The risk would be the downside if it dropped to 35. So lets say you buy a little protection, 1 50 August Put for 2.50. Thus in same scenario (57) you would risk only -$50 max and to downside at 35 you would pick up +$1250 on the Put which would cover most of the loss on the Reverse Ratio Calendar Spread and maybe have a $500 loss.

So what downside do we give up for greatly to completely reducing risk of loss up or down? Instead of harvesting lets say $1.25 at 50 May close X 10 =$1250 profit its 8X$1.25=$1000, plus the downside Put loses .50 or -$50 so the total is $950 gain instead of $1250 gain in ideal situation?

In this case a 30% decrease in profit for a 90% reduction in potential losses approximately.

Am surprised have not seen this idea discussed in books. Does anyone use such a strategy? What do the experts here think of this?

Thanks in advance, darp
 
I suggest using an option calculator to draw your position pay-off graph. Do it for a few scenarios: higher / lower IV (check IV 1 year range, and at least +/-20%), a few data points before expiration (now, in 5, 10, ... days). See attached for BAC.

You'll find out again that there's no free lunch. You reduce your risk at the expense of your reward, and your expectancy is negative due to slippage and commissions. You can't escape the necessity of correctly forecasting the underlying's price and / or the options' IV over the life of your position.

<img src=http://www.elitetrader.com/vb/attachment.php?s=&postid=1055627>
Quote from darp:

... Am surprised have not seen this idea discussed in books. Does anyone use such a strategy? What do the experts here think of this?

Thanks in advance, darp
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You're adding vegas at the expense of gammas when running a ratio favoring the buy-side. Yuo've not modeled a change in implied vols. I wouldn't be concerned with running the strategy on an index, but you're running a lot of vol-risk in your 4x5 calendar.
 
Appreciate all 3 responses so far. Did check out the other threads some now will do so more later.

cnms2, That was very kind on the charts, so to make it realistic you took a real world case(BAC) and showed the up and down IV change effect. What it shows is that the upside is no risk. Even with IV drop rewriting at end of May would be a profit lock and maybe even better.

Looked at http://www.ivolatility.com/options.j?ticker=bac&R=0 and see it is low IV stock and May is lower IV than June, so with filtering for IV edge even better result would occur.

What tool did you use to get those charts? Does it automatically get the data for you? I have hoadley free version but am planning on buying the upgrade. I also use IB although new to it, it probably has more tools than I know of. With them commissions are almost free and 50% of time I can get 1/2 way between Bid and Ask. Options are >10 times easier and cheaper to trade now that 20 years ago :-)

So bottom line is that using a under or reverse ratio does eliminate the risk from 2 ways to 1 way(down in this case).

That begs the question, doing it both ways, Buying a long straddle 5 each side, and selling a near by straddle 4 each side?

Has anyone tried similar approach?

I have been a directional stock trader in past and been very fortunate to have done well last 3 years(over 50% compounded yearly) BUT always at great risk, in 2004 lost $100k in 3 days.

Now from prior success want to really lower risk, if can make 3% a month average with very small risk would be happy with it, hence why started this thread. Folks here have impressive knowledge no need for me to reinvent the wheel, instead ask expert wheel makers.

Would a dual under ratio 5 bot 4 sold calendar straddle be likely to average 3%+ a month if played on 10 stocks in different sectors?

TIA, Darp
 
Darp,

Many of us went through your experience of getting nice results in the beginning, but at some point we got stunned by a large unexpected loss. I suggest to learn about money management (position sizing), if you didn't already have. With options you can easily get over leveraged.

When you buy a longer term option you have to keep in mind that most likely you buy implied volatility, and your position will be hurt by its drop over time.

No matter what position you open, there's no way to go around of having to predict future underlying's price and / or options' implied volatility. Also, there's no way around the relation between the risk and reward.

There are various opinions, but I am with the side that considers options trading a zero sum game, having negative expectancy due to the slippage (mainly) and commissions costs.

To draw pay-off graphs I use an Excel spreadsheet for which I've written a few Visual Basic routines.

From what I heard, Hoadley offers a good inexpensive package, but I have no direct experience with it.
 
I will confess up front that I do believe in the holy grail, even if never find it, by believing in it, more likely to get closer to it. In fact there are risk free ways of making 3-4% per year on options, but that is not as good a some money markets, and is known about.

On position sizing have read Van Tharp and even went to one of his seminars. He is considered the father of Sizing and puts huge emphasis on it. His book Trade your way to Financial freedom was a breakthrough for me.

Yes thats the danger of options, position sizing, its much much easier to lose 50-100% with options than stocks. Hard to hold back on the leverage.

Nice job on VB programing!

For directional trading the B/A options spread is the killer compared to the underlying. Am not interested in that, looking for premium capture with least possible risk. Although am ignoramus?? or should I say ignorRMBS? (as I had options trade on it last week) on options compared to folks on this board, selling premium non-naked seems a positive sum game to me.

Thinkorswim says 10-30% a year on iron condors and .5% extra per month if you sell credit spreads or calls on index underlying held.

My RMBS trade last week which was an even calendar Put spread using Leap as the far one and stock and selling covered calls on it, during that wild 15 point drop in minutes on rumor(which ended up being backwards caused a $5000 drop then 3000 profit in the same day. Thats what got me thinking that even ratio Cal spreads can get dangerous. If had a under ratio would have done great. As ended up walked away with 2k profit thankfully :-)

Hence willing to give up gain % for risk reduction.

Whats your favorite time premium capture strategy?
 
I've traded several strategies over time, but currently I restrict myself to straight options or verticals front or back month.

I have a different opinion on the probable success of premium selling strategies, but I'll not argue with you, Thinkorswim or anybody else.

Just be careful, and good luck!

PS: If it were so easy to make 3-4% a month, why wouldn't more people do it? It's not that easy.
 
Please do your own calculations. You'll learn more doing them yourself, and it'll also be less time consuming for me. :)
Quote from IV_Trader:

cm2 , can your apply diff % changes to diff month ? Many times front and back month IV is not increasing(decreasing) by the same percentage (+/- 20% in your example)
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Indeed, if you can do it, one would make a fortune. Just a tiny few do it, and indeed very rich from it. Buffet does close to 2% and ...

But that is my min goal.

Thanks for your input.
 
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