Advanced Spreads 153 in Visual C#

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Advanced Spreads 153
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long call will create a buy on the underlying of 100 shares per option while the two short calls will create a short sell of 200 shares of CAT stock leaving a net short sell of 100 shares, which will develop margin that the investor must be prepared for The inverse would occur for the put spread: the short sell from the long put would offset one of the long purchases from the short puts leaving 100 shares of purchased CAT at the short put strike price of $2800 Risk control on ratio spreads can be very subjective because such spreads have limited risk on one side Time value is always on your side, and the temptation is to allow the spreads to run regardless of market movement because of the remaining time value The best risk control for ratios is a soft stop technique using the value of the underlying because it is dif cult to predict the spread value with any degree of accuracy for a hard stop If the underlying asset price breaks resistance or a change in the volatility trend occurs, the ratio spreads should be monitored for liquidation These spreads have a tendency to get out of control quickly in rapid market movement despite the low delta, and the trades should be monitored carefully; they are not set-it-and-forget-it trades like a bull call spread or outright option purchase
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Double Ratio Spread
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The double ratio spread is a ratio spread on both sides of the market The double ratio can be dif cult in its risk-to-reward ratio unless the spread is constructed on both sides as a credit or at least a very small debit In addition, a double ratio generates six commissions, so use caution when trading advanced multiple options spreads that generate a lot of commissions These spreads are used frequently, but they are not often placed simultaneously Let s look at a model of the double ratio using the two previous ratio spreads
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Advanced Options Trading
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Profit/loss by change in CAT common price $ 360 180 0 180 360 540 720 900 1850 2150 2450 2750 3050 3350 3650 3950 4250 4550
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Double ratio model Powered by Option Vue 6
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(call ratio and ratio put) which have a small debit premium combined, not including costs of trading You can see from Figure 74 that the trade has a very wide window of pro t opportunity, except for the small area in the middle where both purchased options would be at the money and would expire with little or no value The trade has almost no potential for gain until expiration when all the time value is retired Just as with the individual spreads themselves, you can see the unlimited risk on the outside of the short strike prices once the short premium is exhausted
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Ratio Diagonals
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Ratio spreads can be done as diagonal spreads using options in different expiration months The risk of doing a calendar or diagonal ratio is that the earlier expiration options could be in the money and cause an exercise of the option into the underlying asset and change the delta of the spread The most common diagonal ratio
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Advanced Spreads 155
is to use a purchased option in a longer-term expiration month while selling options in a short-term expiration month to take advantage of the advanced time value decay on the short-term options If you look a back at Figure 621, we could construct a ratio using the Aug expiration 32 call for 446 while selling two of the May expiration 35 calls for 154 each The net premium would still be a debit of 154; however, the advantage is that if CAT stock remains below 35 for the term of the May options, then the entire premium of the May short calls of 292 is applied to the breakeven of the August 32 call which would remain an outright call option Should the CAT price rise above 35 at expiration of the May option, then two short 35 calls would be exercised into 200 shares or a short delta of 200 against the long August call option delta of 594 percent, leaving a net short delta of about 140 percent This would develop signi cant margin Diagonal or calendar spreads can be very effective at reducing costs on long-term options; however, the risk tolerance for the trade should be that of a net short or long position depending on the construction of the trade Ratio spreads in general do not have to be one to two; they can be any ratio It is common to have one to three or more depending on the implied volatility of the position Ratios of this nature are best done at maximum implied volatility because the short options will increase in delta and vega quickly
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