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18. Ratio Put Spread
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Scenario:
This trader feels that current implied volatility is at relatively high levels. The thinking here is that the market should consolidate after its big drop. The trader now believes reduced volatility and a slow downward drifting of price are likely. Consequently, an order to execute a ratio put spread is placed with the broker.
Specifics:
| Underlying Futures Contract: | February Live Cattle | |
| Futures Price Level: | 62.50 | |
| Days to Futures Expiration: | 30 | |
| Days to Options Expiration: | 20 | |
| Option Implied Volatility: | 15.5% | |
| Option Position: | Long 1 Feb 62.00 Put | - 0.675 ($270.00) |
| Short 2 Feb 60.00 Puts | + 0.150 ($ 60.00) x 2 | |
| - 0.375 ($150.00) |
At Expiration:
| Breakeven: | 58.375 (60.00 strike - difference between strikes + 0.375 debit). |
| Loss Risk: | Unlimited; losses continue to mount as futures fall below 58.375. |
| Potential Gain: | Maximum gain of 1.625 ($650) peaks at 60.00 strike. |
Things to Watch:
Be very sure that prices will not go into a sharp decline. But, if a slow drop is anticipated this may be a good strategy. A rally will produce a small gain or loss depending on the strikes chosen.
Follow-up Trading Strategies
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