1x2 put spread strategy

Discussion in 'Options' started by sukikra, Jan 8, 2011.

  1. sukikra


    Hi Guys, new to the forum and kind of new to options trading

    I saw the following trade done on 10yr treasury futures on friday

    Buy 500 put 118.0 @18
    Sell 1000 put 117.0 @ 9

    i think at the time the market was trading around 119.0

    Now my question is, with this trade being bought for flat, where is the risk ? i see the obvious risk of that if the trade falls below the 116 breakeven then it starts to lose money, but surely the trader could just unwind the trade somewhere between 118-117 ? What greek risk does this trade hold ?

    Thank You
  2. spindr0


    116 breakeven is at expiration.

    Prior to expiration, you're losing 2X lower delta of short 117p while making 1X higher delta of long 118p. The position is net negative delta so if it starts dropping tomorrow, you're underwater immediately, possibly never to see breakeven.
  3. sukikra


    but how can you lose money from this trade when it actually costs 0 initially.

    If the underlying price stays above 118, then the short wont be exercised, only if we go below 116 could we lose money(at expiry). If inbetween 118-116 , could you not just unwind the position for profit ? (as the long would have gained intrinsic value).

    Fine the strategy has net negative delta, but that doesnt lose you money in real terms.
  4. sukikra


    ok i understand that the strategy has a negative net delta.

    But how does the strategy lose money in real terms?

    With the strategy costing flat, then if the underlying goes up, it doesnt matter as the short puts wouldnt get exercised.

    If the market goes inbetween 118-117 couldnt the owner of the strategy just unwind it, and selling the strategy for much more due to the long puts having intrinsic value now. (thus never allowing the strat to go below 116 breakeven).

    So how come one in real terms lose money ? sorry maybe for the newbie question but cant figure it out.
  5. The best way to get a sense of the profit and loss potential for this and any trade, I think, is to simply have a look at a risk graph. The following site has risk graph and prose explanations of almost every type of option strategy possible:


    I don't know if its the best site of its kind, but it's at least a decent jumping off point. Optionetics offers a free trial where you can input the trade and it will bring up a risk graph on your specific trade. You can then customize it to find out what would happen if implied volatility changes, p&l on any given day during the trade's life, etc.

    About your trade, I don't like the term "1 by 2," the pet name used by all those gurus on CNBC and their option action show. You'll never see the term 1 by 2 in any of the major books on options. That name says nothing about the trade. Your trade is a classic frontspread. It's the opposite of a backspread and has an opposite risk profile. It's also (and probably more often, these days) referred to as a vertical ratio spread. It's usually done for a slight debit or even money if you're lucky (as it was in the case you cited), but can occasionally be put on for a credit. As you will see when you explore the risk graph, you can definitely lose money on this trade, although I for one think it's a very good trade and the probability of being profitable on this trade is statistically good, all things being equal. The important thing to remember is that it is net short of options. You have a bear put spread that makes money as the market moves down and you're financing it with a farther out of the money short put, which loses money as the market moves down. The trade will perform well if the underlying stays flat or moves lower fairly slowly and gradually, and doesn't go too far below the short strike. Fast and big moves are the enemy of this strategy. If the market makes an abrupt move lower, the trade won't have had the opportunity to benefit from the the passing of time and the short puts (negative gamma) will really begin to drag on the position. Yes, you could unwind it at any time, but you'll have to book a loss (albeit relatively small, if you're nimble and vigilant). What you need is a good resource on trade management. Anthony Saliba's books offer concrete, practical tips on managing losing trades. I don't normally trade this one so I don't have too much to say. For very good information on the mechanics of the trade itself, there is no better resource than Macmillan's books, notably __Options as a Strategic Investment__. Again, though, check out a risk graph so you can see how the trade performs through various permutations of price and time.
  6. 1) The put-skew can steepen against you in the interim giving you a "headache". :eek:
    2) You're focusing too much on expiration where you can speak about the position with more "certainty". You have to deal with what happens up until then. :cool:
  7. Position is +delta.
  8. It's a short backspread. Not worth the effort as you will accumulate deltas rapidly on a decline. Better to simply pay the 4 ticks to fly it off.
  9. rosy2


    you might not see it in a book but you hear it all the time from guys shopping orders
  10. spindr0


    I'm not familiar with treasury futures or their options so I may be assuming a lot. Be that as it may, your quotes seem bizarre to me. How do you get 9 more pts of premium for a strike only one point higher? Bad quotes or some multiplier involved?

    To answer your question, check the deltas of the two options. If the delta of the 117p is more than 1/2 that of the 118p, you're going to lose if your ratio spread drops immediately because the extrinsic loss on the 117p will exceed the intrinsic gain of the 118p. The more it drops, the more delta you lose.

    It's possible that if it drops soon and keeps dropping, you may never see breakeven (look at a time series risk graph).
    #10     Jan 9, 2011