Bat's favorite option strategy

Key Concepts

• One by Two Put Ratio Spread
• Omnidirectional Bullish Trade
• In-the-Money (ITM) Puts
• Out-of-the-Money (OTM) Puts
• Put Skew
• Credit Spread
• SPY (ETF tracking the S&P 500)

The One by Two Put Ratio Spread: A Time-Tested Strategy

This video highlights the "one by two put ratio spread" as the speaker's number one trading strategy, even after 40 years of experience. The strategy is particularly favored in the current market environment, which is perceived as consistently moving higher.

Strategy Mechanics and Rationale

The core of the one by two put ratio spread involves:

• Buying one put option: This put is positioned "closer to the money," meaning it has a strike price near the current market price of the underlying asset.
• Selling two put options: These two puts are "further out of the money," meaning their strike prices are significantly below the current market price.

This structure is designed to generate a "nice fat fat credit." The rationale behind this is rooted in the concept of "put skew."

Understanding Put Skew

The speaker explains that in products like ETFs such as SPY (which tracks the S&P 500), puts often trade with significant "skew." Put skew refers to a situation where put options are "over inflated relative to the call price." In simpler terms, the premiums for puts are higher than what would be expected based on their theoretical value compared to calls.

The Advantage in a Bullish Market

The speaker argues that selling an overpriced asset (in this case, puts due to skew) is advantageous. If the market continues to move higher, as is the perceived trend, the seller of these inflated puts benefits. This scenario is described as "Nirvana," emphasizing the ideal outcome for the trader employing this strategy in a rising market.

Real-World Application: SPY ETF

The SPY ETF is explicitly mentioned as a prime example where this strategy is effective due to its pronounced put skew. This suggests that traders can leverage the inherent pricing anomalies in the options market for this popular index-tracking ETF.

Conclusion

The one by two put ratio spread is presented as a robust and profitable strategy, particularly for traders who are bullish on the market or believe it will remain stable. Its effectiveness is amplified by the phenomenon of put skew, which allows traders to collect a substantial credit by selling overpriced out-of-the-money puts while maintaining a bullish outlook with a purchased in-the-money put. This strategy has remained the speaker's top choice for decades due to its favorable risk-reward profile in specific market conditions.