Virtual Risk Free Spread

J

jones247

Has anyone considered combining a call backspread and a put backspread with a long butterfly. It would be best to structure these spreads with a net credit and right before earnings reporting. With a net credit from these spreads there's virtually no risk. If the stock doesn't move, then you'll profit from the butterfly, or at worst break-even. If the stock goes up, then you'll profit from the call backspread. If the stock goes down, then you'll profit from the put backspread.

Because this structure would cost seven option commissions, it would be best to use a low commission broker like IB for this spread structure.

Any thoughts on the validity of this strategy. Please let me know if you see any weak points or if there's a way to strengthen this strategy.

Thanks,

Walt
 
Quote from faith4more:

Not risk free if moves up or down higher than your sold calls or puts there is risk
More...

Thanks for the repy faith; however, I disagree with your statement. Because of the long positions in the backspreads, it would be quite profitable if it moves higher or lower than the options I sold. That's the purpose of a backspread... to profit because of the underlyer's STRONG movement beyond the price of the sold options. There are several websites that provide good explanations about the mechanics of backspreads and their profit targets.

Walt
 
Please post an example of your strategy (include month and strike). I can't visualize how the backspreads don't drag the butterfly down. One drawback is that with 7 legs, you're going to have a lot of B/A slippage.
 
Without considering the debit/creidt of the entire package, the risk would be a stock gapping up or down slightly and meander there for weeks. It would move away from the sweet spot of the fly and it would be in the dead zone of the backspread which is between the bt and sld strikes.
 
There's an entire thread by Maverick on this spread.
If you slap it all on at once, there's no edge to it. But still a fun position to think about.
 
USG is due to report on tomorrow @ 11:00 AM Est. The following represents the data as of 4:00 PM 1/28/08:
Market price = $33.25

Transactions to structure:
Buy 1 call @ 3.70 - $30.00 strike
Sell 2 calls @ 1.95 - $32.50 strike
Buy 1 call @ 0.80 - $35.00 strike

Sell 1 call @ 1.95 - $32.50 strike
Buy 2 calls @ 0.80 - $35.00 strike

Sell 1 put @ 2.80 - $35.00 strike
Buy 2 puts @ 1.55 - $32.50 strike

Although I could combine the entries of the call backspread into the butterfly, I intentional separated it for demonstration purposes.

The total cost of this structure (not including commissions, which is immaterial with a brokerage like IB) is $65 per contract (100 shares). Although there may be slippage, since I would probably hold them until expiration, unless a better opportunity arises, slippage would not be a major issue. Nonetheless, if slippage is my only major concern, then I'm in great shape with such a strategy.

Walt
 
Just did a risk profile after seeing eaxctly what you are talking about. There is risk if volatilty falls which it usually does on most stocks after earnings. If it closed at todays price tomorrow and vol falls by 15% you lose around $92 per contract. That loss gets less as it moves towards $30 or $36 where it turns to profit on each of those outside strikes. But the danger is it stays between and you lose some vol. A 25% decrease in vol would be around a $150 loss per contract

It will work much like a straddle.
 
The loss in IV cuts both ways. Both the long positions and the short positions would lose IV. Although the reduction in IV would hurt the long positions, it would be offset by the benefit to the short positions that I sold.

Walt
 
Jones I just did a detailed analysis through TOS risk profile. It may offset some but the numbers I gave you are accurate. On complex spreads you must use software or can get in trouble. Your idea looked great until I started playing with vol. You will lose unless it moves a good bit up or down or the vol stays up . The vol should come down question is by how much.
 
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