Trade Idea (Hedge): SPY July 16th 416/2 x 432 Put Ratio/Zebra
Pictured here is a July 16th 416/432 Put Ratio with twice the number of contracts on the long side as on the short which I can either do as a standalone directional shot or (in this particular case) a hedge against a portfolio that is longer than the net delta of this particular setup.
Here's how it's constructed:
Start out by (a) looking to buy 2 x (or some multiple thereof) the 75 delta long put in the expiry in which you want to erect your hedge and selling the at the money put, which should be around 50 long delta.
The initial result of this setup from a delta standpoint should be: (2 x -75 delta) - 50 delta = 100 short delta.
You can proceed to fiddle with which strikes you want to buy such that your break even is at or slightly above where the underlying is currently trading. This is to ensure that you're not paying more than you have to, as well as to ensure that the extrinsic in the short put pays for all of the extrinsic in the longs -- hence, the clever nickname for this ssetup: the Zero Extrinsic Back RAtio or "Zebra."
The end result:
Max Loss: 29.71
Max Profit (Theoretical): 418.29 (Assuming the Underlying Goes to Zero)
Delta: -89.52 Dynamic
Break Even: 417.15 versus 416.74 Spot
Ordinarily, I look at ratios in two pieces, the first being the long put vertical consisting of the short put and one contract of the long; the second, the "extra" long. Max profit is realized in the long put vertical aspect on a finish below the short put strike. From a trade management standpoint, I generally opt to take this aspect off at or near max, which in this case would be something a little short of 16.00 (the width of the spread) and then either (a) allow the remaining long put to ride; or (b) sell another at-the-money short put, converting the ratio into a static, standalone spread to protect myself against a whipsaw back up into the remaining long put strike. There is, after all, little point in keeping the long put vertical aspect on after it has converged on max because you won't can't make anything more on it (but can naturally still lose money on it).
Here's how it's constructed:
Start out by (a) looking to buy 2 x (or some multiple thereof) the 75 delta long put in the expiry in which you want to erect your hedge and selling the at the money put, which should be around 50 long delta.
The initial result of this setup from a delta standpoint should be: (2 x -75 delta) - 50 delta = 100 short delta.
You can proceed to fiddle with which strikes you want to buy such that your break even is at or slightly above where the underlying is currently trading. This is to ensure that you're not paying more than you have to, as well as to ensure that the extrinsic in the short put pays for all of the extrinsic in the longs -- hence, the clever nickname for this ssetup: the Zero Extrinsic Back RAtio or "Zebra."
The end result:
Max Loss: 29.71
Max Profit (Theoretical): 418.29 (Assuming the Underlying Goes to Zero)
Delta: -89.52 Dynamic
Break Even: 417.15 versus 416.74 Spot
Ordinarily, I look at ratios in two pieces, the first being the long put vertical consisting of the short put and one contract of the long; the second, the "extra" long. Max profit is realized in the long put vertical aspect on a finish below the short put strike. From a trade management standpoint, I generally opt to take this aspect off at or near max, which in this case would be something a little short of 16.00 (the width of the spread) and then either (a) allow the remaining long put to ride; or (b) sell another at-the-money short put, converting the ratio into a static, standalone spread to protect myself against a whipsaw back up into the remaining long put strike. There is, after all, little point in keeping the long put vertical aspect on after it has converged on max because you won't can't make anything more on it (but can naturally still lose money on it).
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