The recent introduction of the new “Vol Step” Options Strategy was very well received and everyone seems excited about it. One follow up question I received caught my attention and I’d like to address it today.
“Why do we use a Vertical Put spread? Why not just buy a single Put option?”
That’s a great question thank you. So both a single Put option and a vertical Put spread are both trying to accomplish the same thing. They are both looking to capitalize on the price of the underlying asset going lower. The difference lies in the risk reward profile of each of them. Looking at a chart for both will illustrate the difference:
9/8 Vertical Put Spread
9 single Put
With options trading (and with most things in life) you don’t get the best of everything, it’s always a trade off. Let’s look at the advantages of each:
Advantages of the Vertical Put spread
– The break even point at expiration is much closer, in this case at 8.40$ vs the single put breaking even at 7.69$.
– The maximum profit at expiration also happens very quickly, in this case at just 8$. In order for the Single Put to make the same profit it needs to get to the mid 6’s.
Advantages of the Single Put:
– There is potential for far higher profit. Several multiples of the original capital outlay in fact, where as the Vertical Put spread can only achieve it’s max profit and no more.
– Single puts are more sensitive to short term movements. So even though at expiration it requires a large move, from day to day it can profit more (the pink daily profit line in the charts)
So it’s a clear trade off. Vertical Put spreads profit quicker and have a higher success rate, but Single Puts when they are timed correctly can make a lot more money. To me they are both good trades for different circumstances.
Vertical Put spreads are best when the time frame is defined. The trade we just put on is to capitalize on another step down in UVXY by expiration, and then likely repeated for the following expiration and so on. If we are planning on holding it close to or right into expiration this is the better choice.
Single Puts are best when the time frame is open ended, as it is in our VTS Tactical Volatility Strategy with VXX puts. For those trades we are just simulating the underlying asset and we don’t know what the time frame for the trade is. I’ve had Tactical Volatility trades last 1 day, and I’ve had them last many months without touching them. Open ended trades are better suited to single leg puts.
The Vol Step Strategy revolves around the decay of the underlying and utilizing defined expiration cycles so Vertical Put spreads are the trade of choice here.
Have a great weekend!
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