Track That Trade. Aug 5, 2011. Ratio Roll Down

I just made a trade for my own account.

It brings up some interesting points and I thought we should look at it as a stand alone play. I have used this type of trade many times as a portfolio adjustment – but because it involves the sale of more spreads than I bu, I only make this play when I am under invested and am willing to sell more put spreads.

This specific trade is fairly ‘greek neutral’ but would become nicely profitable on a non-volatile market decline and the passage of time. Right now, the market is volatile and there is no reason to make a play that depends on a decline in volatility.

Yet, this is an interesting play on its own. When I make the trade in my account, I will not see it (nor will I remember that I made this trade) because my purpose was to exit one spread and roll it to another. As a stand alone trade, the position remains open and can be examined.

The Trade

RUT = 713
RVX = 40.56. This is a huge increase over the past two days (43%).

The trade

The quote

Buy 4 RUT Oct 690/700 spread
Sell 7 RUT Oct 630/640 spread

Midpoint is $100 credit. Let’s assume we make this trade for even $$. By legging into this spread, I paid $200 – and I thought that was a good price. But the Iv increase since I made the trade resulted in wider market and there is no telling at what price we could get filled.

The greeks

In order, the options in the above table are:
+7 Oct 630P
-7 Oct 640P
-4 Oct 690P
-4 Oct 700P

Risk Graph

Here’s a better view of the risk, ignoring how it would look at expiration (which is now a lifetime away when markets are volatile).

11:17 AM 110805

Trade Rationale

The primary way that I use a trade such as this is to roll down. I must re-emphasize that this increases ultimate downside risk, so is not appropriate when you are trading all the risk you want to handle.

The market play on this trade is to see a relaxation (probably temporary) in IV over the next week or two. If the market hold hre or drifts a bit lower, there ought to be a profit opportunity. I do not see this trade as a long-term hold. However, it does offer a nice area of profitability as expiration nears. This is both the good and bad news:

  • Good news
    • Expiration risk looks much better over a range where help is needed
  • Bad news
    • Holding this trade subjects trade to possibility of additional losses – when loss potential is probably high enough

IV Crunch

One hour later the market has recovered. RUT is 721 (down only 6) and INDU is up 100.

Here’s the current quote:

Spread quote at noon

Note that the midpoints suggest we must pay a debit to enter this spread now, when earlier the midpoint told us that collecting a credit was possible.

RVX declined from the current panic highs (43) to ‘only’ 39. Not a big profit, but an indication that an IV reduction will hurt the 7-lot of shorts more than it will decrease the value of the 4-lot long position.

Update 110808

The market is lower
IV is higher (RVX is 44 at 11:25 CT)
This trade which places us at greater risk on a big decline, is profitable on the way down.

This time it is working as a stand alone trade.

Monday, one weekend later. After S&P downgrades US debt

Update 110909. EXIT

Take the money and run

It’s always to know where we would get filled here, but with the midpoint near =$930, let’s just assume that we could take a credit of $400 and call it a day.

As a stand alone trade, we earned a nice profit. If this were part of a portfolio because the trade were made as an adjustment, it would be left untouched and NOT reversed.

4 Responses to “Track That Trade. Aug 5, 2011. Ratio Roll Down”

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