Wednesday, July 19, 2006

Trading P.I.T. Session 4

Tonight's Trading PIT class with Bill Keevan was about Ratio Backspreads. We covered both the Call Ratio Backspread and the Put Ratio Backspread. This is a credit trade where we are expecting a strong directional move in the stock. However, if the stock moves against you, you still come out ahead. Let me give you a moment to think about that. If you are dead-wrong on the direction the stock is going, you can still make money. Isn't that a nice trick? There is a downside: if the stock just consolidates and doesn't move either direction before the options expire, you stand to lose money.

This strategy involves simultaneously Selling an In-The-Money (ITM) Call (or Put) Option and using the credit to Buy 2 or more Out-of-The-Money (OTM) Calls (or Puts). There is a lot you need to know about the Options in question in order to make this trade work for you. Again, this is one of those times I can't really tell you a lot about how to structure the order, you'll need to take the class so that I don't reveal the proprietary entry & exit criteria.

I have created an Excel template for a evaluating a Ratio Backspread. It allows you to quickly evaluate the entry criteria, by comparing 3 ITM contracts to 3 OTM contracts and allows you to change the number of contracts to Buy and Sell. Unless you have taken the class, you may not understand how to use it, even if you have taken the class, you may not know how to use it. I just created it to help me evaluate Ratio Backspreads for myself. If you're interested it can be downloaded by clicking here.

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