We have previously discussed the concept of short Straddles with no upside risk. This trade involves shorting the at-the-money (ATM) Straddle and then buying an out-the-money(OTM) Call. The total credit received must be larger than the width of the spread between the Calls to eliminate the upside risk. A Put Ratio Spread using the same strikes accomplishes the same thing synthetically. A graphic compared a Capped Straddle to an ATM Put Ratio Spread. P/L graphs and tables of the two strategies were displayed which demonstrated they were virtually the same. The Put Ratio Spread had a lower Buying Power Reduction (BPR) and there was no dividend assignment risk from a short Call.
Our study was conducted in the SPY (S&P 500 ETF) using data from 2005 to the present. We chose the options with the expiration cycle closest to 45 days to expiration (DTE). We compared the Capped Straddle (buying the furthest out Call possible while still leaving the spread as a Capped Straddle) to the ATM Put Ratio Spread. We managed winners at 25% of max profit if possible or held the trade to expiration.
A table of the results included the success rate, average P/L, average days in the trade and average P/L per day. The table showed that the results were very close. Managing winners at 25% improved the win rate and avg. P/L per day significantly. A second table compared the same strategies, managed at 25%, in all environments versus and when filtered for an Implied Volatility Rank (IVR) above 50. Again the end metrics were “virtually the same.” The benefit of the Ratio Spread was no dividend risk but the Bid-Ask Spread is wider in the long ATM Put. Tom said that “the importance of this segment was to show you that Synthetics are priced perfectly and how there is no real arbitrage opportunity out there…”.
For more information on Synthetics see:
Best Practices from July 27, 2015: "Synthetic Positions"
Market Measures from September 18, 2015: "Short Synthetics | Pricing"
Strategies For Your IRA from December 23, 2015: "Shorting Stocks With Modified Synthetics"
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the detailed results of our study comparing a Capped Straddle to an ATM Ratio Spread.
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