By: Steve Smith
With market volatility, as measured by the “CBOE S&P Market Volatility Index (VXX)” has sunk back down to pre-teen levels of 12. While it can certainly stay low, this basically represents a floor in the price.
And sets up an attractive situation for employing a backspread strategy.
A backspread consists of all calls or all puts with the same expiration in which one sells a closer-to-the-money strike and buys a multiple number of contracts in a further out-of-the-money strike. The goal is to have as minimal an outlay or debit as possible while achieving the highest ratio of long option contracts to short.
I tend to use these on the put side, whether it be portfolio protection or bearish bets.
The goal of a backspread is to buy as many options as possible relative to the number sold for the lowest cost. A good rule of thumb would be to buy 3 contracts for every 1 sold for even money. Of course, the width between strike prices is one of the determining factors of what ratio can be accomplished.
Think about using them when a stock or ETF has enjoyed a remarkable rally. When gold went parabolic the past few months one could portfolio established a low cost back spread in “SPDR Gold Trust (GLD – Get Rating)” which, after a few days, paid off handsomely.
The Dead Zone
The drawback is that there’s a… Continue reading at StockNews.com
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.
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