I posted this trade idea on Twitter last week and it generated some healthy discussion so I wanted to also open it up for comments here on the blog.
The trade is a Put Ratio Backspread on RUT. Here are the details:
Date: December 16th, 2019
Current Price: 1639.86
Trade Set Up:
Sell 1 RUT January 17th, 2020 1610 Put @ $16.15
Buy 2 RUT January 17th, 2020 1540 Puts @ $5.75
Premium: $465
Max Profit: $465 on the upside, unlimited on the downside
Max Loss: $6,535 (difference between the strikes less the premium received)
The idea with the trade is that the market is either going to continue to grind higher in which case we keep the $465 in premium and make a 7.12% return on capital at risk, or the market tanks and we can potentially make some nice gains on the downside.
The risk with the trade is that we have an orderly correction in the range of -2% to -7% and we end up in the “valley of death”.
The trade is positive Vega so any correction will likely be associated with a jump in implied volatility which may help to limit losses if fall into the valley.
Another drawback with the trade is the volatility skew. We are buying puts at 18.30% volatility and selling the put with 14.59% volatility, but that will always be the case with a trade like this.
Let me know what you think about this trade in the comments. If you were to place this trade, where would you set a stop loss?
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
