Ratio Spreads

Hi All,

I have been reading a lot recently about put ratio spreads and I wanted to see if anyone on here trades them. From doing research it seems like they would be a decent skew play. What I want to know is:

1. Do you hedge them with a further bought put or neutralize the delta somehow?
2. Where do you set your strikes?
3. What time frame has worked best for you?

Just to clarify I am talking about a ratio spread for a net credit like 2 to 1 or 3 to 1 . I hope my lingo is up to forum standards, seems like ignorance is not taken lightly here. Thanks in advance.

 

I've done them some myself. I suggest:

1. Buy a further OTM put (3rd leg) to reduce your margin requirement (like a BWB).
2. Don't go for the biggest credit you can get; this increases your risk if the market moves down too quickly.
3. Aim for making the profit area as wide as possible with a small credit or even money. i.e. make the distance between strike 1 (long) and strike 2 (shorts) as far as possible.
4. Around 30 days out seems to work best.

The way I've been doing it is a directional play, not for taking in a credit. I use the credit to buy a wider profit zone.

 

IMO, you are doing this backwards. These spreads work well when vol skews change or you have a thesis on where a stock or index will or will not trade over a time period. Just looking to enter a ratio spread randomly might not give you the result you want.

Bob

 

rmorse is right if you're entering these trades as a straight profit trade.
I could see entering a trade like this on an index to hedge a long portfolio. If the market moves up it doesn't cost you anything. If the market moves down you make money to offset your portfolio losses (if properly managed).

 

I did ratio spreads a lot when I was trading full time. But I did it with a purpose. A good example was GLD. At that time, the OTM calls were skewed much higher than the ATM calls and OTM puts. GLD was trending up and there was a large demand for OTM calls. I felt this skew was wrong. So I would set up my Market Making pricing to be more aggressive selling calls that were OTM and more aggressive buying ATM options and OTM puts. The Skew never changed but the volatility of the up moves vs the down moves rarely proved the skew correct. It was profitable with "little" risk.

IMO,the important thing to get out of this is that profitable option strategies start with thesis not the desire to enter a spread. Look at the current markets, then decide the best way to profit from your expectations and the current pricing.

bob

 

That's a good post Bob. Not sure they will get it. Maybe after a few reads.

 

Well as one of "they", I get it.
I was just trying to answer OP's question directly without judging.

 

Thank you for your responses!

Bob: I completely agree, I cant stand to hear people talk and "rinse and repeat" trades. Nothing works all the time and you definitely need a thesis on where price will or wont go. For example I would use the 2 - 1 put ratio after a sharp down move and put the sold strike slightly below a resistance level. That way if price rallies, I keep small credit, if price stays around the resistance level, I make a decent return. If price break resistance, I look to get out do the trade. What do you think of something like that? The thesis would be a flattening of the skew and resistance holding. I paper traded this strategy on SPX on Tuesday my strikes being 1875 x 2 and 1900 x 1 and it worked out well.

stevegee58: Thanks for your suggestions! Do you stick to 2 - 1 or do you trade other ratios like 3 - 1 or 4 -1? ?

 

Sure that can work. You are selling vol when they expand, but keep in mind that you don't have to hold that position until expiration. You can close it or add to it as the market moves and prices change.

 

I've looked at 1-3-2 BWBs but never traded them. Supposedly 1-3-2 is better closer to expiry but I find plenty of opportunity with 1-2-1.