Short the SPY 83/85 call spread in APR

Just got filled on a 3-lot of APR 83/85 short call spread in SPY for a credit of $0.55.

There are 28 days until this contract expires, which is at the low end of what is acceptable with these types of spreads. Usually, you’d like between 28 and 45 days to expiration. The 45-day spreads give you more credit, but the 28-day spreads give you just enough to make the trade.

The trade assumes that SPY (S&P 500 ETF) will stay below $83.00 by next month’s expiration. Some shenanigans can happen during dividend quarters, but that happened this week so dividend risk is not a factor.

The risk on this trade is pre-defined. It is the difference between my liability at the 83 strike and my protection at the 85 strike. So, $2.00. Since we got credited money in our account to put this trade on, we can use that credit to offset the total risk and end up with $2.00 minus $0.55 equals $1.45 risk. The ratio comes out to roughly risking $3 to make $1. Kinda the opposite of what you may be used to seeing if you trend trade with stop losses and limits.

The reason we take that risk/reward is because the probability of the 83 call expiring worthless is about 77% based on current volatility. I got that number from the option software I use, but it’s pretty basic stuff.

Now, some greek talk. First up is Delta. Obviously I win if the market does not rally too much, so I’m basically short the market. Short the underlying is the same as short Deltas. Next up is Gamma. Positive Gamma works in your favor and is benefit received from buying stuff. We sold this spread so we get stuck with negative Gamma. The cost of doing business. Not to worry too much for now since Gamma usually become an issue much closer to expiration. The next greek is my favorite: Theta. It is one of the main factors in placing this trade. We want time decay to be on our side. And the short call has more negative Theta than the long call hedge, so we net a positive Theta. Finally, there is Vega or volatility. If volatility increases, we can expect that to hurt our position since it increases the chances our short strike will get hit. If you get hurt when something goes up, you must be short that something, no? In fact, we are short Vega with this spread.

This is a typical option spread to have on if you want to tempt the rally, but not tempt it recklessly. We’re basically taunting the market to reach 83 in SPY in the next four weeks. We have some insurance at the 85 strike in case the market takes our challenge and barrels past it.

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3 Responses to “Short the SPY 83/85 call spread in APR”

  1. Anonymous Says:

    This is all great, but, I was expecting some TA to show why these strikes are safe.

  2. Milk Trader Says:

    This is not a TA trade but rather a statistical trade and uses current volatility to calculate probabilities of success, which for this trade is 77%. It has criteria for entry (time to expiration, preferred delta of short strike) but also a lot of trader discretion. The basic trader assumption here is that the rally in the market may bring the SPY to 85 in four weeks, but it’s not likely given the recent runup. Unlike a rules-based system that uses TA and has no opinion of future price action, this option trade does hold an opinion of future market direction.

  3. Anonymous Says:

    thanks for sharing….. What Options software are you using?

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