Today is Monday, 4/11/22 and the trading day is over. Prior to last Friday’s close, I had a bearish bias on SPX. The price action that led me to that bias is well documented here in the blog post Understanding Price Action. Based on that bearish bias I initiated 2 new positions. In the first trade I bot (2) Apr14 SPX 4450 Puts, bot (4) Apr18 SPX 4400 Puts and sold (6) Apr14 SPX 4400 Puts for an $18.50 Debit or $3,700. I refer to that type of position as a RS+ because it’s the same as if I bot a (2×6) Apr14 SPX 4450/4400 Put Ratio Spread (RS) plus bot (4) Apr18 SPX 4400 Puts. Another way to look at it is that the position is basically a combination of Put Vertical Debit spreads and Calendar spreads. The reason it’s such a good option strategy is because the Puts that are being sold in the position have higher implied volatility (IV) than the Puts that are being bought. That gives the position an inherent advantage compared to many other option positions that don’t have that benefit. The second trade was the same structure as the first trade only the long Apr14 Puts were bot at the 4475 strike instead of 4450 to offer more potential downside profits. That trade was initiated for a $26.00 Debit or a cost of $5,200. Total cost of both positions was $8,900.
Today, the SPX did indeed move lower, and as I frequently do when price moves in the expected direction I Delta Hedged (DH’d) the position to reduce cost and reduce the Delta (directional) risk. I simply rolled down the Apr14 SPX 4475 and 4450 Puts to the 4400 strike. That generated a Credit of $66.00 or $13,200.
After the adjusting trade was made I had now locked in a minimum profit of $4,300 ($13,200-$3,700-$5,200) and, more importantly, I still owned an 8-lot Apr14/Apr18 SPX 4400 Put Calendar spread. See the risk profile below.
That’s today’s recipe for profit! Even if you don’t understand the mechanics of the trade the most important takeaway is the Delta Hedging concept! Reduce cost and directional risk when the opportunity presents itself or you’ll likely find that whatever profits you may make one day will often disappear the next day!
Thanks. How do you choose the initial strikes for buying puts vis a vis current price when you buy them? Do you use delta or something else to decide?
Also take a look at the Low Probability Trade post
Thanks. How do you decide which strike price to buy the puts at, compared to current price when you make the purchase?
I’d suggest you read the 30 Delta Option post
how do you decide to either buy a long or short call … or open an RS+ when you have a directional bias? thanks
I’m not sure what you’re asking me here but I’ll take a shot at an answer. I never initiate a position using short options since that is a undefined risk position. If I feel that the chart setup is a particularly strong one then I’ll often initiate a position by simply buying Calls or Puts and then ‘leg into’ a lower Delta risk position by turning those long options into a spread. If I’m less confident in the chart setup but it’s still a legitimate setup I may initiate with a spread and then leg into a lower Delta risk position by selling further OTM options (turning a Vertical Debit spread into a Condor). The other factor in my decision process relates to the current Delta risk in my SPX Beta weighted *portfolio*. If, for instance, my overall portfolio is long Deltas I may initiate a new bullish position with a Call RS+ instead of long Calls to avoid taking on too much Delta risk for the portfolio.
thanks.. i mistyped but thats the answer i was looking for. thanks!