During the May Butterfly you saw me executing a BOX spread without much explanation - let me make up for that now.
Lets say we have the following spread in our portfolio; RUT 450 - 480 debit (a leftover from a Butterfly) currently price @ 27.80. This spread still can make $2.20 extra, since the max value of the spread is $30.00. It is a bit sad to say good bye to this profit potential, on the other hand the risk close to expiration is also weighting more and more every day. Although the 480 put only has a delta of 16 giving us a 84% chance the 480 will be ITM at expiration. Still risk is risk.
For this reason I started to "box" the spread in by using a ratio put spread. I will show you in two step - first the basic box and then the ratio.
The box finishes of the vertical spread and takes all risk away - at expiration the box will pay me 500 times $30.00. In the graph you can see the P/L line flat line. But this box has cost me $2.10 - so a big chunk of the potential I have given back to run away from the risk. If I left the trade as is - I would have been better off just to close the original vertical debit spread.
The next order pays for the box by means of a put ratio. The box now only cost my 90ct - and the risk of my trade move from the 480 to the 450. From where the puts have a delta 16 to where the puts have a delta of 4.
Be aware I add risk to the trade - by having naked puts in ratio in the portfolio - but the risk move further away from the current market level.
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