"There's an element of institutional-level business that recognizes the edge obtained from seasoned service coupled with expert executions. I exist to provide that edge for those institutions."
– Bill Peters
Futures & Options Broker
20. Put Ratio Backspread
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Scenario:
The trader is getting very nervous about the stock market. He is sure that the market is overvalued, but not sure when the break will occur. Also, the trader does not want to stand in front of a runaway bull market. This trader is will to NOT participate in upside gains to be certain that the position will be held when the market drops dramatically. He consequently enters into a put ratio backspread.
Specifics:
| Underlying Futures Contract: | December S&P 500 | |
| Futures Price Level: | 940 | |
| Days to Futures Expiration: | 105 | |
| Days to Options Expiration: | 105 | |
| Option Implied Volatility: | 16.2% | |
| Option Position: | Short 1 Dec 930 Put | + 7.10 ($1775.00) |
| Long 2 Dec 920 Puts | - 4.00 ($1000.00) x 2 | |
| - 0.90 ($ 225.00) |
At Expiration:
| Breakeven: | 909.10 (920.00 strike - 10.00 difference between strikes - 0.90 debit). |
| Loss Risk: | Limited; losses bottom out at strike of long puts. At 920.00 the maximum loss of 10.90 ($2725.00) occurs. |
| Potential Gain: | Unlimited; gains mount as futures fall past 909.10 breakeven. |
Things to Watch:
Depending on the exact strikes chosen, a trader could come away with a small gain or loss if futures continued their rally. The worst scenario is to have a mild bear market with volatility dropping.
Follow-up Trading Strategies
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