When to sell a put spread versus long a call spread?

Hi all,

Selling a put spread is a bullish play usually with an inverse risk reward but the aim is to collect premium, generally high win rate. Buying a call spread is a bullish play usually with a positive risk reward but you pay premium, generally a lower win rate. Their overall expectancy over the long run can be the same.

They both essentially express the same view of the market. Is the only factor in deciding which one you use based on whether your view on volatility is that its under or overpriced?

Or do you tend to find people only do one or the other?

Thanks,
Tom

 

Buying a call spread vs selling a put spread of the same strikes is synthetically the same thing. They will have the same profit/loss (with a couple of exceptions such as a hard to borrow stock).

 

well I suppose I was thinking more an ATM or slightly OTM long call spread versus an OTM put spread. Both benefit from the stock going up. But with very different risk:reward, PoP, margin etc

 

1) Theta - works in the favour of the put-spread seller and against the call-spread buyer.
(If stock remains static, then the former keeps all their premium, and the latter looses all
their premium.)
2) Range of profitability. Say stock is at 100, and you sell the 90-80 P spread for 3 credit, or buy
the 110-120 C spread for 3 debit, so they are equidistant.
Put-spread - any stock price over 87 means a profit - stock has to fall more than 13% for
you to lose.
Call-spread - stock MUST be over 113 to make a profit - stock has to rise at least 13% for
you to win.
3) Vol - as you rightly mentioned, this is crucial. Generally, sell spreads during high vol (with
expectation that it will contract).
4) Capital req - in the above example the call buyer only needs $300/spread, but the put seller
needs $700 in margin.

 

Sell both, use the premiums you collect on both to offset risk on both. Profit.

 

Hi Tom

Here are a few backtests that might help with your question.

First a long call spread on SPY with our default values of days to expiration of 30 days and deltas short leg = .30 long leg = .15. The annual return is based on the stock price at the open of the trade as the denominator so we can compare apples to apples.



Next is the short put spread. As you can see the returns are much better 1.55% vs 0.21% and the win rates much higher 83% vs 38%.



The way I like to approach your decision is to first find the best way to trade the spreads, with testing days, deltas, spread width percents, spread price yields, and exit strategies.

Once you have found a good way to trade the strategy then you can test for triggers like volatility levels or other factors. It is key to test in sample and out of sample and try to figure if the parameters you are identifying will work going forward. At ORATS we have paper trading to test the strategies and go back and compare the paper trading to the backtest to see if your strategy is performing as expected.

Here's an example of an optimized short put spread I ran on a few factors. This strategy uses a stop loss delta, has shorter days to expiration, is closer to the money and has wider strikes than the above. The returns and Sharpe are much better.



Finally, here's the above strategy using an entry and exit trigger. Even though the annual return is lower in the strategy with trigger, the average daily return is higher 0.014% vs 0.012% and adds about 0.5% to the annualized return.

The trigger being used we call etfSlopeRatio, the put-call slope divided by a related ETF -- for SPY this is the IWM slope. This trigger was identified in an exhaustive search program we have built that tests many of our historical core data sets. This trigger indicates a sell when the slope is in the higher range for the ratio. This makes some sense because even though a short put spread is short skew, this particular put spread has more vega in the short put and will benefit from a flattening skew that lowers the IV or from theta.



I hope this helps. Let me know if you have any questions.

 

Thanks Matt, very helpful.

 

Ok, good Tom, thanks for the like...

 

I like your thought process.

 

I understand selling put spread as a bullish bet because I need wing protection. I never understand buying a call bull spread.

Long call caps my loss, why do I also want to cap my gain with a spread? Buying OTM calls has < 50% win rate so I need high reward potential to make it worthwhile.

I have not done any analysis or test to validate call vs call spread so it is just an untested opinion.