The Call RS+

There are plenty of references to the RS+ trade on the blog and in my twitter feed. It’s certainly one of my favorite option structures. Basically, a RS+ is a version of a 1×2 (or 1×3) Ratio Spread in one expiry plus 1 (or 2) long options in a later expiry. It could also be described as a Vertical spread plus either a Diagonal or Calendar spread. As you look at the positions in this post, simulate them on your own platform and then deconstruct them so you understand what they really are. It’ll be worth your time!

One of the characteristics of the RS+ is that it’s a long Vega trade. Using SPX as an example, a long Vega trade will increase in value if the VIX rises and will decrease in value if the VIX falls. Understanding that the VIX typically (but not always) falls if SPX rises then it wouldn’t make sense to trade a Call RS+, right? Why select a long Vega trade to play for a move higher in SPX? Let’s take a look and see why.

Below are 3 fills that I got in the last 2 trading days. All three are 1x3x2 Call RS+’s; one is in the Sep16/19 expiry and the other two are in the Sep23/26 expiry. In that Sep23/26 expiry, one is a Vertical plus a Diagonal and the other is a Vertical plus a Calendar. Each serves a slightly different purpose.

Below is the risk profile of all three of the SPX Call RS+’s combined. With SPX up approximately 1% since I started buying these I have a decent profit with a very large potential profit if SPX continues to rally.

When I started buying these spreads SPX was stretched to the upside after having rallied strongly without a decent pullback. I don’t like to buy breakouts, I much prefer to buy pullbacks or retracements however I can offset the risk of buying a breakout or when SPX is relative expensive by utilizing the proper structure of the RS+. See the RS+ that expires in 4 days below. It’s clearly a bullish position and would only see a maximum profit if SPX rises from near 4100 currently to 4150 at Friday’s expiry but notice the Delta of the position. It’s currently negative Deltas because I included a short Diagonal Credit spread in the structure so I didn’t really end up overpaying for a bullish trade when I’m expecting SPX to likely experience a pullback soon. Might pullback, might not. I have no idea. That’s why I chose this particular structure. Pullback? Fine. No pullback? Fine…as long as SPX doesn’t move up too far too fast. What if it does?

That’s where the risk profile below becomes my insurance plan just in case SPX rips higher. Those two RS+’s with the Sep23/26 expiry are loaded with positive Deltas and would really profit from a strong move higher in SPX. Because they’re long Vega they’ll hold up pretty well if SPX instead has a pullback with a corresponding increase in the VIX.

I only have time to make this a short post but I’ll leave you to figure out why I use a Call RS+ for a move higher in SPX when it’s a long Vega position. The one hint I will give you is this; when you breakdown the RS+ into it’s component Vertical and Calendar/Diagonal spreads you can calculate the approximate value of what the RS+ will be worth at expiry. The Vertical spread component is Vega neutral and offers a fixed profit amount at expiry if price has moved beyond the long and short Call in the spread. For instance, a $20 wide SPX Vertical spread can’t be worth less than $20 at expiry if both Calls (long and short) expire in the money. It’s only the Diagonal or Calendar spread component that derives much of it’s value from the implied volatility. Think about it! 🤔

9/13 Update: The CPI report prior to today’s open has ignited a spike lower in SPX with the index currently down by over 3%. I’ve been voicing my concerns about /ES being expensive over the past week due to the explosive nature of the rally, specifically the fact that price hasn’t retraced back to prior day’s HB support. When price doesn’t do that it’s vulnerable to a sharp reversal. This was my tweet from this morning prior to the RTH (Regular Trading Hours) open.

Okay, good for me on explaining why price could drop sharply after the move had already started! Everyone is Nostradamus in hindsight! 😏 That’s true, but if you look at the reason I originally bot the Sep16/19 Call RS+ it was because SPX was expensive so I wanted a trade structure that didn’t involve a lot of positive Delta risk. In fact, the bullish trade was short Deltas at yesterday’s close. Well, with today’s bearish reversal I’m out of that position now. You’d think I took a major hit on that bullish position. Not really, see for yourself.

I originally paid $3.50 for it and I closed it out for $3.25 this morning. All in all, not too bad taking just a 7% loss on a bullish position while the SPX was tanking! Another reminder how important trade structure is in options trading! However, lets not forget that I also owned two Sep23/26 RS+’s also and those were long Deltas…a lot of Deltas. 😣 As I mentioned earlier, the long Vega of a Call RS+ helps minimize the loss if SPX moves down and the VIX moves up. Even better still is the ease in which a Call RS+ can be hedged for downside risk simply by buying 3-day (Fri/Mon) time spreads (Put Diagonals or Calendars). That can set up a combined position to actually profit from a move lower or higher. See my tweet from yesterday.

After price broke down having been extended to the upside I dumped all three of the Call RS+’s. If you’re confused why I exited those positions on a breakdown instead of waiting for a retracement it’s because a breakdown in an overbought market is completely different than a breakdown in an oversold market! Price was due for at least a pullback so I was looking for any excuse based on the price action to add more short Deltas! Below is my current risk profile.

You may have noticed that the risk profile shows that I lost $65,000 today. 😬 Fortunately that’s not exactly correct! When you Delta Hedge positions by rolling down the strikes to reduce initial cost of a position that’s not reflected in the current risk profile. For instance, below is one of the roll downs that I did today by selling a Credit spread. The amount that I collected for selling those Credit spreads doesn’t show up in the current risk profile because it’s no longer a part of the position.

Below I am sharing with you my actual P/L monitor from today only. This will likely be the first and last time I do that! Without knowing the size of my account there’s no way for you to judge whether this profit is appropriate for my account. Am I saying that a profit can be too large for an account? Yes, if a trader is exposing too much of his or her trading capital to generate that profit. I can only assure you that I stayed well within my personal risk parameters today. The only reason I’m sharing this is to confirm for you that a trader can learn to hedge a portfolio against both a large move higher or lower in the price of the underlying! I could’ve had a profitable day even if SPX had rallied instead of dropping. Many traders have a good day now and then but having a profitable day or week is of little positive consequence if that profit is lost the next day or week. Risk on, risk reduced is my mantra. Risk on at good location for a directional trade and risk reduced when the opportunity to do so presents itself. Greed kills in trading!

One last thing. You may have noticed that my portfolio currently consists of one instrument; SPX. I still trade other stocks or ETF’s occasionally but the fact is that I choose to spend most of my time focusing on SPX and /ES. That’s how I’m able to trade and still tweet and do other things throughout the day. Conventional wisdom is that a trader should have multiple instruments to hedge their risk. Okay, if that works for you, go for it. I choose to hedge my portfolio by hedging my one underlying instrument. To each his own!

Questions or comments below.