The vertical bull put spread is a neutral-to-bullish multileg options strategy (Figure 4). Premium is collected through the sale of a put (obligation to receive the underlying stock). Part of the premium received is used to buy a put (right to sell the underlying stock) at a lower strike price. Selling a put theoretically represents risk equal to the contract strike price. Buying a put limits the risk to the difference between the sold and bought strike prices (strike spread) less any premium collected. For example:
SLD: SPY NOV 140 PUT @ 4.55 (receive $455)
BOT: SPY SEP 137 PUT @ 3.45 (pay $345)
Net Credit: $455 - $345 = $110
$-At-Risk: Difference in Strikes – Net Credit ((140 – 137) x 100) - $110 = $190
MAX Gain/Loss: Max Gain = $110 (36.67%) / Max Loss = $193 (-63.33%)
Collateral for this position would generally be determined by the strike spread. Collateral of $300 would be required to establish this position and is the basis for all G/L calculations.
Benchmarking Options Strategies
The spreads described here are typical in that this trade is usually constructed to sell the ATM and use the proceeds to purchase insurance a certain percentage away from ATM. This is a classic, risk-controlled trade. ISE took the framework of this trade and blended it with modern portfolio theory to develop a truly diversified portfolio of vertical spread trades to help transform a trading vehicle into a potential investment vehicle.
Spread pairs that are very close to or ATM are more likely to have the underlying stock trade through them and incur maximum losses (high delta/low gamma). Pairs that are further away from ATM are less attractive from a net credit perspective, but require larger moves of the underlying to put the position at risk (mid delta/mid gamma). Pairs that are quite far away from ATM exhibit higher levels of price volatility (low delta/high gamma) due to the low absolute-price levels at which they trade. Being positioned too close or too far away from ATM presents unique risks for each. We identified optimal spreads from each of these categories and combine them into a single basket. In doing so, we created the ISE SPY Bear Options Overlay Index (VCS) and the ISE SPY Bull Options Overlay Index (VPS).