Trade Idea: Defined Risk Options Setups to Short the DIAmonds
With the DIA at fairly long-term overhead resistance, I thought I'd set out how I'd potentially take a bearish assumption directional shot using a defined risk options setup where the max loss is known from the outset. There are several ways to go about this:
1. Short Call Vertical
Buy the September 15th 351 call and sell the September 15th 346 call, resulting in a five wide spread for a 2.70 ($270) credit. Max profit is realized on a finish below the short call strike at 346; max loss, on a finish above 351.
Metrics:
Max Loss: 2.30 ($230)
Max Profit: The width of the spread (5.00) minus the credit received (2.30) or 2.70 ($270).
Break Even: 348.70
Probability of Profit: 55%
ROC %: 117% at max; 58.7% at 50% max.
Delta/Theta: -12.03 delta, .79 theta
Variations:
1) Go farther out-of-the-money with your spread, giving yourself more room to be wrong, with the trade-off being a smaller credit received and a lower ROC %-age. Example: September 15th 356/361 short call vertical, 1.09 ($109) credit on buying power effect of 3.91 ($391) (which is also your max loss). 27.9% at 50% max; 13.9% at 50% max; -10.02 delta, 1.14 theta. Max loss is realized on a finish below the short option leg of the setup (i.e., 356).
2) Widen the at-the-money spread, but to not more than a risk one/make one setup. Example: September 15th 346/354 Short Call Vertical, 3.95 credit on buying power effect of 4.05 ($405) (which is your max loss). 97.5% ROC at max; 48.8% at 50% max. -19.54 delta, 1.42 theta. Here, you're risking 4.05 to make 3.95, which is about as close to a risk one/make one setup as you can get.
If you look at the delta metrics of each as an indicator of how bearish your assumption is, the out-of-the-money spread has the lowest of the bearish assumptions at -10.02 delta; the risk/one make one 8-wide 346/354, the greatest at -19.54. Generally speaking, the setup should match your assumption somewhat, so if you're presumably less confident of a retreat from this level, then you should probably go with the out-of-the money spread; more confident, with the wider, at-the-money spread.
2. Long Put Vertical
Buy the September 15th 349 put and sell the September 15th 343 put, resulting in a 6-wide spread for which you pay a 2.50 debit (which is your max loss). Max profit is realized on a finish below 343; max loss on a finish above 349.
Metrics:
Max Loss: 2.50 ($250)
Max Profit: 3.50 ($350)
Break Even: 346.50
Probability of Profit: 50%
ROC %-age: 140% at max; 70% at 50% max
Delta/Theta: -17.95/.72
Variations:
As with the short call vertical, you can naturally widen the spread, with my preference being to keep the ROC %-age metrics around a risk one to make one.
3. Long Put Diagonal
Buy the September 15th -90 delta 369 put and sell the +30 delta August 18th 339 for a 21.75 ($2175) debit, resulting in a 30-wide calendarized* spread.
Max Loss: 21.75 ($2175)
Max Profit: 8.25 ($825)
Break Even: 347.25
Probability of Profit: 54%
ROC %-age: 37.9% at max; 19.0% at 50% max.
Delta/Theta: -60.65/2.99
A couple of things stand out about this setup. First, look at the short delta; it's bigly at -60+. Second, look at the price tag; it's also bigly relative to the other setups. That being said, the max profit potential is also greater than the other setups, but would require a finish below the short leg at 369. It does, however, have one additional advantageous element, and that is its calendarization which allows you to roll out the short option leg for additional credit should the setup not work out immediately. This results in a reduction in cost basis for the setup, improves your break even and therefore your profit potential.
On a more practical level, I personally don't look to get max profit out of this type of setup. I look to take profit at 10% of what I put it on for and then move on. Here, that would be around $220 or so; given the setup's delta, that would require a move of around 4 handles or so to the downside, which wouldn't be much to ask given price action in the underlying.
4. Zebra**/Put Ratio Spread
Buy 2 x the September 15th -75 delta 375 puts (for a total of -150 delta) and sell 1 x the +50 delta put at the 345 for a 13.65 ($1365) debit. Max loss is realized on a finish above 375; max profit isn't defined.
Metrics:
Max Loss: 13.65 ($1365)
Max Profit: Undefined***
Break Even: 347.35
Probability of Profit: 53%
Delta/Theta: -101.19/-1.23
As with the long put diagonal, the short delta is bigly -- the biggest of all the setups at -100, so if the underlying moves down one handle, the setup will be in profit by 1.00 ($100). Conversely, if it moves 1.00 to the upside, it will be in the red by 1.00, at least at the outset, when its dynamic delta remains at -100.
Since this setup does not reach a "max," taking profit is somewhat subjective. As with the long put diagonal, I generally take profit at 10% of what I put it on for and move on. $136 in profit isn't particularly compelling here, so I could see looking to take profit on movement toward the most recent swing low at 337, which would result in 8 handles or so of -100 delta profit ($800). An added disadvantage to hanging out in this setup for too long for "moar" is that there is some degree of assignment risk if the short put goes deep in-the-money, particularly if it does that toward expiry.
5. High Probability of Touch Long Put
Buy the September 15th 342 Long Put for a 4.55 ($455) debit
Metrics:
Max Loss: 4.55 ($455)
Max Profit: Undefined
Probability of Profit: 32%
Break Even: 337.45
Delta/Theta: -40.72/-4.52
I generally don't do standalone longs for a number of reasons I won't get into here, but thought I'd set out some kind of common sense approach that utilizes one of the metrics most traders that seem inclined to use this approach don't discuss (or aren't aware of) and its "Probability of Touch" -- the likelihood that price will "touch" the strike at some point during the life of the contract.
The general rule of thumb is that POT is about 2 times the delta of the strike. Given the fact that this is a -40 delta strike, the POT is around 80%, implying that the options market is pricing in about an 80% probability that price will touch the 342 strike at some point during the life of the contract.
* -- It's "calendarized" because one leg is in a different expiry than the other, as compared to the short call and long put verticals, above, where both legs are in the same expiry.
** -- A "Zebra" is a "zero extrinsic back ratio" spread with the short option legs paying for all of the extrinsic in the longs, resulting in an at-the-money break even.
*** -- It's technically 347.35 ($34,735), but that assumes DIA goes to zero, which (just taking a stab here) probably isn't going to happen.
1. Short Call Vertical
Buy the September 15th 351 call and sell the September 15th 346 call, resulting in a five wide spread for a 2.70 ($270) credit. Max profit is realized on a finish below the short call strike at 346; max loss, on a finish above 351.
Metrics:
Max Loss: 2.30 ($230)
Max Profit: The width of the spread (5.00) minus the credit received (2.30) or 2.70 ($270).
Break Even: 348.70
Probability of Profit: 55%
ROC %: 117% at max; 58.7% at 50% max.
Delta/Theta: -12.03 delta, .79 theta
Variations:
1) Go farther out-of-the-money with your spread, giving yourself more room to be wrong, with the trade-off being a smaller credit received and a lower ROC %-age. Example: September 15th 356/361 short call vertical, 1.09 ($109) credit on buying power effect of 3.91 ($391) (which is also your max loss). 27.9% at 50% max; 13.9% at 50% max; -10.02 delta, 1.14 theta. Max loss is realized on a finish below the short option leg of the setup (i.e., 356).
2) Widen the at-the-money spread, but to not more than a risk one/make one setup. Example: September 15th 346/354 Short Call Vertical, 3.95 credit on buying power effect of 4.05 ($405) (which is your max loss). 97.5% ROC at max; 48.8% at 50% max. -19.54 delta, 1.42 theta. Here, you're risking 4.05 to make 3.95, which is about as close to a risk one/make one setup as you can get.
If you look at the delta metrics of each as an indicator of how bearish your assumption is, the out-of-the-money spread has the lowest of the bearish assumptions at -10.02 delta; the risk/one make one 8-wide 346/354, the greatest at -19.54. Generally speaking, the setup should match your assumption somewhat, so if you're presumably less confident of a retreat from this level, then you should probably go with the out-of-the money spread; more confident, with the wider, at-the-money spread.
2. Long Put Vertical
Buy the September 15th 349 put and sell the September 15th 343 put, resulting in a 6-wide spread for which you pay a 2.50 debit (which is your max loss). Max profit is realized on a finish below 343; max loss on a finish above 349.
Metrics:
Max Loss: 2.50 ($250)
Max Profit: 3.50 ($350)
Break Even: 346.50
Probability of Profit: 50%
ROC %-age: 140% at max; 70% at 50% max
Delta/Theta: -17.95/.72
Variations:
As with the short call vertical, you can naturally widen the spread, with my preference being to keep the ROC %-age metrics around a risk one to make one.
3. Long Put Diagonal
Buy the September 15th -90 delta 369 put and sell the +30 delta August 18th 339 for a 21.75 ($2175) debit, resulting in a 30-wide calendarized* spread.
Max Loss: 21.75 ($2175)
Max Profit: 8.25 ($825)
Break Even: 347.25
Probability of Profit: 54%
ROC %-age: 37.9% at max; 19.0% at 50% max.
Delta/Theta: -60.65/2.99
A couple of things stand out about this setup. First, look at the short delta; it's bigly at -60+. Second, look at the price tag; it's also bigly relative to the other setups. That being said, the max profit potential is also greater than the other setups, but would require a finish below the short leg at 369. It does, however, have one additional advantageous element, and that is its calendarization which allows you to roll out the short option leg for additional credit should the setup not work out immediately. This results in a reduction in cost basis for the setup, improves your break even and therefore your profit potential.
On a more practical level, I personally don't look to get max profit out of this type of setup. I look to take profit at 10% of what I put it on for and then move on. Here, that would be around $220 or so; given the setup's delta, that would require a move of around 4 handles or so to the downside, which wouldn't be much to ask given price action in the underlying.
4. Zebra**/Put Ratio Spread
Buy 2 x the September 15th -75 delta 375 puts (for a total of -150 delta) and sell 1 x the +50 delta put at the 345 for a 13.65 ($1365) debit. Max loss is realized on a finish above 375; max profit isn't defined.
Metrics:
Max Loss: 13.65 ($1365)
Max Profit: Undefined***
Break Even: 347.35
Probability of Profit: 53%
Delta/Theta: -101.19/-1.23
As with the long put diagonal, the short delta is bigly -- the biggest of all the setups at -100, so if the underlying moves down one handle, the setup will be in profit by 1.00 ($100). Conversely, if it moves 1.00 to the upside, it will be in the red by 1.00, at least at the outset, when its dynamic delta remains at -100.
Since this setup does not reach a "max," taking profit is somewhat subjective. As with the long put diagonal, I generally take profit at 10% of what I put it on for and move on. $136 in profit isn't particularly compelling here, so I could see looking to take profit on movement toward the most recent swing low at 337, which would result in 8 handles or so of -100 delta profit ($800). An added disadvantage to hanging out in this setup for too long for "moar" is that there is some degree of assignment risk if the short put goes deep in-the-money, particularly if it does that toward expiry.
5. High Probability of Touch Long Put
Buy the September 15th 342 Long Put for a 4.55 ($455) debit
Metrics:
Max Loss: 4.55 ($455)
Max Profit: Undefined
Probability of Profit: 32%
Break Even: 337.45
Delta/Theta: -40.72/-4.52
I generally don't do standalone longs for a number of reasons I won't get into here, but thought I'd set out some kind of common sense approach that utilizes one of the metrics most traders that seem inclined to use this approach don't discuss (or aren't aware of) and its "Probability of Touch" -- the likelihood that price will "touch" the strike at some point during the life of the contract.
The general rule of thumb is that POT is about 2 times the delta of the strike. Given the fact that this is a -40 delta strike, the POT is around 80%, implying that the options market is pricing in about an 80% probability that price will touch the 342 strike at some point during the life of the contract.
* -- It's "calendarized" because one leg is in a different expiry than the other, as compared to the short call and long put verticals, above, where both legs are in the same expiry.
** -- A "Zebra" is a "zero extrinsic back ratio" spread with the short option legs paying for all of the extrinsic in the longs, resulting in an at-the-money break even.
*** -- It's technically 347.35 ($34,735), but that assumes DIA goes to zero, which (just taking a stab here) probably isn't going to happen.
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