Ratio Spreads | Options Crash Course: Strategy Management

[Music] so welcome back to the option crash course strategy series my name is jim schultz in this video the final video of the series we are going to cover the ratio spreader we're going to follow the same protocols that we followed to this point we're going to cover winners we're going to cover losers we're going to cover that dance floor but first let's talk about how a ratio spread sets up so the ratio spread this is arguably the most versatile most flexible strategy that is available to us and it consists of two parts you have one long option you have two short options a long option is usually situated at the money or slightly out of the money the two short options are then placed further out of the money because you have two short options relative to every one long option this is going to be a net credit strategy so for example let's say that the stock was at 50 you might set up a put ratio spread using the 49 strike and the 48 strike you would buy a put at the 49 strike and then sell two puts at the 48 strike but let's say the stock was 75 you might set up a put ratio spread using the 75 and 72 and a half strikes you would buy a put at the 75 strike the at the money strike and then you would sell two puts at the 72 and a half strike the out of the money strikes now there are a few things that you want to be aware of that you want to be cognizant of when it comes to putting on a ratio spread first the wider you go with your ratio spread the greater your maximum potential profit this is because the vertical spread that's kind of baked into the center of the ratio spread could potentially be worth more money the trade-off here is the wider you go with that ratio spread the lower your credits collected second you want to make sure that on entry you collect a credit that is economically significant you'll see why in a couple of minutes third we typically prefer put ratio spreads over call ratio spreads and this is for the same reason that we typically prefer short puts over short calls the market wants to go higher over time so battling a short call over cycle after cycle after cycle in a market that wants to grind higher can really be a stick in the mud alright so managing winners everybody's favorite this is actually going to be a little bit more involved than what we've seen to this point and that's because with a put ratio spread you can actually make money in both directions if the stock rallies then you're going to keep the credit collected because those options are going to move further out of the money but if the stock falls then you could potentially make more money this would happen at expiration if you pin that short strike you'll keep that credit collected but you'll also pick up the width of the ratio spread since we don't hold our undefined risk trades inside of 21 days to go we're actually not super interested in that stock falling scenario since that's never really going to come into play so we want to focus our energies on the stock rallying scenario how do we manage those winners because ratio spreads are so versatile and they are so flexible you're going to have to use a lot of discretion in handling these situations but if the stock does rally and the options to move further and further out of the money you're going to want to look to capture most of the credit that you have collected so for example let's say you put a ratio spread on on entry for 60 cents if you can buy that thing back for 20 cents a week later then you might want to consider doing that let's say you put a ratio spread on for 90 cents if at some point in the future you can buy that thing back for 30 cents or 33 cents you might want to consider that one too again there's no hard cutoff point here so you're going to have to use your experience as your guide but do you remember when we said it needs to be economically significant this is why you want to put yourself in a position to where if the stock does rally and your p l approaches that credit collected that it is meaningful all right so now what about those losers well our reference point for adjusting is going to be that short strike as long as the stock is above your short strike then you do nothing all right easy enough but now what do you do if the stock does fall down through your short put strike how do you handle that situation well the first thing you're going to want to do is check the value of the vertical spread that is baked into the center of the strategy if you can take that off from nearly max value then go ahead and take that off so for example if you have a one dollar wide ratio spread then the vertical spread that's in the center is one dollar wide if you can take that off for 85 cents that's almost max value if you have a 2.50 wide ratio and you can take off the vertical spread for two dollars that's also almost max value now where is the cutoff point for determining if it's enough on the vertical spread to take it off well that's largely going to be up to you but i can tell you what i do if i can't get at least 80 percent of the vertical spread's value then i do not take it off if you are able to close out of that long port vertical for near max value now all you have left is a short put so manage it in the same way that we did in the short put video just keep in mind that now your total credits collected are the credits on order entry and the credits from selling out that vertical spread okay but what do you do if you can't close out of that vertical spare for near max value well you basically have two options first option you sit and you wait you do nothing you can do this here because either one of two things is going to happen a the stock goes down if the stock goes down then that vertical spread is going to increase in value and you're going to be able to close it down you close it down you manage that extra short put accordingly and you move on or b the stock actually rallies if the stock rallies then those options could be out of the money again this is an even better scenario but the second option of course is you can roll the whole thing out in time you can pick the whole thing up the short put the vertical spread all the pieces and roll it out in time if you do this you will reduce your risk and add duration to the trade all right easy enough but what do you do if the stock just keeps falling what do you do if no matter what you do the stock will not come back well again remember if you choose to manage your losers somewhere around 2x to 3x of total credits received is a really good marker so for example if your total credits from order entry from rolling out from closing out that vertical spread if all of these credits were four dollars for example and buying it back for 12 would be a 2x loser and buying it back for 16 would be a 3x loser all right so those are the winners and those are the losers but what about everything in between what about that dance floor well since you have that extra short put and this strategy is so flexible rolling out in time as your default option is not a bad move but remember you can always use ivr as your guide if ivr is still elevated then keep it on if ivr has fallen then take it off wow you guys made it the option crash course strategy series has now come to a close i sincerely hope that you guys got some value from these videos guys if i can ever help you in any way please do not hesitate to reach out you guys can email me jayshultz at tastytrade.com or you can hit me up on twitter at jsultsf3 so that is it and i will see you guys next time you

Channel: tastytrade

Views: 12,854

Rating: 4.9473686 out of 5

Keywords: options, trading, tastytrade, trade management, call options, put options, undefined Risk, naked options, bullish, bearish, skew, put ratio spread, call ratio spread, long vertical spread

Id: VVvCH_KK1AA

Length: 8min 13sec (493 seconds)

Published: Sat Feb 27 2021