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There’s nothing wrong with placing speculative trades, as long as investors understand they have a low probability of success.

The OTM vertical spread

This strategy isn’t always discussed, but traders can use it to speculate. The costs are low because of the credit received from the short option. It’s still a low-probability event but higher than buying the long option by itself.

Suppose a trader predicts Caesars will increase above $101 by expiration. (See the table, right).

Buy 1 x 100 calls in August

Sell 1 x 105 calls in August

This is done for a $100 debit.

Objective Probability of Profit Max Profit Max Loss

A price increase above the strike + the debit paid = $101 Low $400 Costs paid of $100

Account Buying Power Required

$100

Michael Rechenthin, Ph.D., aka “Dr. Data,” is the head of research and development at tastytrade. @mrechenthin

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CHERRY PICKS RIPE & JUICY TRADE IDEAS

Naked Puts for the Risk Averse

By Michael Rechenthin

I

n the Tactics section of this issue, an article entitled Three Ways to Play Long Odds (p. 49) offers three strategies for placing speculative trades. Here, readers will find an “anti-speculative” strategy that’s less risky than buying stock.

It’s called the naked put in a liquid exchange-traded fund (ETF) such as SPY, QQQ, IWM, DIA or XLU.

This is the equivalent of taking a long position in a stock but with less risk. For an example, take a look at Anti-speculative strategy, right. SPY is the equivalent of buying shares of the S&P 500 three years ago. The naked put (PUT) is the equivalent of selling an at-themoney put in SPY using the option expiring closest to 30-days until expiration. This is held and then repeated.

Notice the simple put underperformed during this period. But it’s OK to underperform the market, even though financial gurus often suggest investors have to outperform a benchmark to be successful.

The advantage of the short put is it tends to make money more consistently and with less volatility on a month-to-month basis. Less volatility simply means the position will have a tendency not to move too much. It will have lower peaks and higher troughs.

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Anti-speculative strategy

The naked put is selling an at-the-money put in SPY using the option expiring closest to 30 days until expiration. Notice the volatility is less than buying SPY itself.

60%

40% SPY

PUT

20%

-20%

Jan 2018 May 2018 Sep 2018 Jan 2019 May 2019 Sep 2019 Jan 2020 May 2020 Sep 2020 Jan 2021 May 2021 Sep 2021

For a lot of savvy investors, trading isn’t necessarily about making 10%, 20% or 30% returns on a yearly basis because those high returns often come with a higher likelihood of large losses. Instead, many would prefer the consistency that comes with selling a put in an ETF that they wouldn’t mind getting long in.

... the equivalent of taking a long position in a stock but with much less risk.