The Grind-Up Trade

This post is about one of my favorite strategy’s for attempting to profit from a grind higher in SPX. It likely seems a little complicated to someone who hasn’t had any experience with the strategy so this is a reminder here that all of the posts on this blog are strategy’s that Travis and I use in our personal accounts. They are not recommendations of trades that others should make! You’ll be able to see how this strategy performs over time by simulating them on your platform and if you want to add the strategy to your bag of tools later on that will be your decision. Let’s proceed!

Quantifiable Edges tweeted a table of the historical performance of the SPX during Thanksgiving week and the following Monday.

For purposes of this post let’s just say that I’m moderately bullish for the next month or so based on the above table and because I’m expecting a ‘Santa rally’ to carry SPX higher into mid to late December. Of course I could be wrong about that so I’d like a position(s) that could benefit from a grind higher but also, more importantly, have an asymmetrical reward/risk of at least 3:1 plus get paid for the passage of time. That’s not too much to ask, is it? 😊

If I decided to design a position to take advantage of a bullish bias into this Friday’s close I would use an options structure that I call a RS+. I refer to it as RS+ because it’s a 1×2 Ratio Spread in a Friday expiry plus a long option in the following Monday’s expiry. Below I show three separate RS+ positions with expiry’s over the next three Friday’s; November 26th, December 3rd and 10th. I would initiate all three positions on Monday, November 22nd to give me exposure to the upside while reducing my risk as time progresses since one of the three positions will expire each week over the next three weeks.

When I actually place the order I combine the Ratio Spread with the long option to create a ‘custom’ order. I’m likely to get a better fill price by placing the RS+ as a single order than placing the orders separately.

Below is one more look at the same positions. The RS+ viewed another way as a Diagonal spread plus a Vertical spread. Confused? I would be! Look at each of the risk profiles again (and again) until it makes more sense. I use the custom order (#2 of the 3 shown) since it only requires one fill to initiate the position rather than two. The fewer fills means less slippage which can be quite costly over time.

ADDITIONAL THOUGHTS FROM TRAVIS: I’m working on a complete analysis of the RS+ structure. I’ll save those details for a future post. For now, here are a few concepts for you to explore on your own:

1. The RS+ is a complicated spread. To avoid execution issues, it’s best used in only the most liquid underlyings.
2. SPX and SPY are ideal underlyings for the RS+. Besides being extremely liquid they offer the additional advantage of 3x weekly expiries. Those expiries allow you to structure the spread across an adjacent Friday and Monday–another Vega Options special–which produces unique characteristics compared to time spreads across wider expiries.
3. If you’re new to time spreads, note that a time spread’s location relative to the underlying spot price has a much more dramatic effect on the spread than making similar adjustments to something like a vertical, butterfly, or condor. Shifting a time spread along the options chain can entirely change the shape of the expiration graph.
4. Paul’s examples above show what may be the “Goldilocks” RS+ in terms of strike widths and placement relatively to the money. But you should also know that the RS+ is amazingly flexible and can be optimized to virtually any technical setup and volatility environment. The flexibility of the RS+ comes from its hybrid structure, and you can conceptualize it as comprising different combinations of simpler structures: (1) a ratio and a long strike in a longer-dated expiry, (2) a butterfly with the outside long strike in a longer-dated expiry, (3) a long vertical and a diagonal, (4) a long vertical and a calendar. This is why Paul posted multiple arrangements of the same strikes above. If you know these simpler structures well, thinking about the RS+ in those terms may help you start to appreciate its inherent flexibility. I’ll get into this in much greater detail in a future post.