Below is the risk profile of my SPY directional/hedge that was put on 6-22-10 for a debit of -420. I thought the range of SPX would be between 900-1040 and was just trying to devise a play to profit from that. I ended up buying the (10) 104 puts, selling (10) 95 puts, and then selling (6) 101 puts. I was trying to create something like a butterfly with little out of pocket expense in case I'm wrong, but a chance to win big if I'm right in that range. However, I was willing to give up a lot more on the back end in exchange for a little less of an initial debit as I would close the trade out early for a smaller gain rather than possible take large losses on the backside. So I just screwed around with the risk analysis and came up with the first image below.
Now look at the second image, using the same strikes and prices, a simple 104/95 back ratio would have been an initial debit of -550 instead of -420, but look at the possible reward scenario. Both plays have roughly the same breakeven points but the back ratio is potentially much more profitable at +8400 instead of $5000. Even using the expected average gain would be $5000 on the back ratio and $3000 on my trade. This is nothing more than my lack of education as I've never used a back spread before and therefore didn't have this risk/reward scenario already in my head. But clearly an initial debit of -550 versus -420 was warranted in this case. It's great that I'm learning from mistakes, however, I'm probably a little ahead of myself and should probably lower my trading size for a while back to 5-10 contracts as this is really a rookie mistake in my opinion. I just have just yet to put in the time to learn some of the basics.
Now look at the second image, using the same strikes and prices, a simple 104/95 back ratio would have been an initial debit of -550 instead of -420, but look at the possible reward scenario. Both plays have roughly the same breakeven points but the back ratio is potentially much more profitable at +8400 instead of $5000. Even using the expected average gain would be $5000 on the back ratio and $3000 on my trade. This is nothing more than my lack of education as I've never used a back spread before and therefore didn't have this risk/reward scenario already in my head. But clearly an initial debit of -550 versus -420 was warranted in this case. It's great that I'm learning from mistakes, however, I'm probably a little ahead of myself and should probably lower my trading size for a while back to 5-10 contracts as this is really a rookie mistake in my opinion. I just have just yet to put in the time to learn some of the basics.
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