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Saturday
Oct312015

QQQ Nov15 -$92/+$87 Vertical Put Spread: 9.03% Profit Banked in 28 Days

The second trade that OptimalOptions closed was a put spread on QQQ, the ETF that tracks the NASDAQ.

Trade: Short QQQ Nov15 -$92/+$87 Vertical Put Spread

Entry: $0.46

Exit: $0.05 Return: 9.03%

Opened: 22-Sep-15

Closed: 20-Oct-15

Days Open: 28

In mid-September 2015, equity markets were nervous with fears that a slowdown in China combined with a potential Fed hike could de-stabilize the global economy. Stocks we falling and demand for downside protection (via put options) had sky-rocketed, meaning put options were now a lot more expensive. In our view put options had become too expensive and the implied volatility levels were too high.

To take advantage of this we sold out of the money put options on QQQ, the ETF that tracks the NASDAQ, in our model portfolio. We sold QQQ Nov15 -$92/+$87 Vertical Put Spreads for $0.46 net credit. This means we sold $92 put options on QQQ, but to avoid unlimited risk we bought $87 puts simultaneously, both with November expirations.

If our view was correct, the spread would move towards $0.00 from our entry at $0.46, as both puts become worthless given they are expiring out of the money. If our view was incorrect, we could have lost $4.54 (as they spread could move to $5, the different in the strikes, if both were in the money), but that was the maximum possible loss on the trade. The simple payoff diagram for the trade is shown below.

Our downside was clearly much larger than our upside, but the probability in our view of the upside scenario eventuating was so much greater than the downside scenario that we felt the trade still had positive risk-reward dynamics.

In hindsight, we were too early signalling that put options were a sell. QQQ moved lower in the week following our signal and therefore our position showed a loss for a while. However we remained confident that the downturn would be short lived, and volatility was still too expensive, therefore we held on to the trade. This worked in our favour, as QQQ recovered and we were able to buy back the put spread at just $0.05, locking in a 9.03% gain.

The return on our put spread trade was much greater than buying the underlying shares, but we took a much greater risk by selling puts. On balance this trade worked well, although our timing could have been better for entering the trade, waiting another week would’ve given us a higher entry point and greater potential profit.

Trading Record Summary

Number Of Closed Trades: 2

Average Return Per Trade: 13.75%

Average Duration Per Trade: 21