In the tastytrade community on Twitter was a lot of talks about the 1-1-1 and 4-4-1 put spread strategy recently.
Here is the reason why I am not a big fan of this strategy.
First, what is the 1-1-1 put spread strategy:
This strategy is an out-of-the-money put debit spread financed by a further otm naked put.
Here is an example in $SPY:
The 1-1-1 has a break even which is pretty far away.
The break-even point has a delta of 4.
So, just a 4% chance of expiring in the money.
The 4-4-1 trade consist of 4 otm put debit spreads financed by 1 further otm naked put.
Here is an example in $SPY:
The break-even point on this trade is at 313.
A delta of just 5.
You can see the downside of these strategies in the following chart of $SPY.
The market usually grinds up and once in a while it crashes.
And the $VIX explodes:
Based on the closing price of $SPY and $VIX on Feb 19 2020 the market was expecting a one standard deviation move of $14.63 for the next 33 days.
But we got an 8 standard deviation move (about $117).
They tested a similar strategy on tastytrade in 2014 for earnings trades on the put and the call side.
Sunny side up = atm debit call spread financed by a 16 delta short call.
Over Easy = atm put debit spread financed by a 16 delta put.
Here are the result:
Despite a high win rate the Over Easy was a loser.
The reason is that you collect a very tiny credit on these strategies.
The really BIG moves in the market happen to the downside and very often wipe out all of your profits from the past.
When you constantly sell 30 delta puts you collect enough premium over time to withstand a crash.
That’s why we don’t sell 5 or 10 delta puts.
Not enough credit.
In the case of a big crash basically all puts become 100 shares of stock and show very similar losses.
Short calls in an up trending market are also bad strategy as you can see below.
You don’t collect much credit in low IV and when the $VIX explodes they very often lose money despite being directionally right.
How about the upside?
Markets don’t crash to the upside.
We have seen a giant move in $SPY since the March lows.
But it only was a 1.3 standard deviation move based on $SPY $VIX closing prices.
Definitely more manageable.
Is there a way to take advantage of the slow grind and still be protected from a crash?
How about doing the 1-1-1 or the 4-4-1 on the call side?
Let’s have a look.
First the 1-1-1:
Here’s the 4-4-1 to the upside:
As you can see, with the 1-1-1 or the 4-4-1 strategy on the call side you can profit from a slow grind to the upside without any risk to the downside.
If you are interested in options trading check out my book trilogy.
My first book is available on Google Play on iTunes and Amazon.
My second book is available for $5.99 on Amazon, Google and on Apple.
Thanks to all my readers for buying it.
My third book is available on Amazon, Google and iTunes.
Stephan Haller
Legal disclaimer: These are not trade recommendations. Options involve risk and are not suitable for all investors. The trades shown above are for educational purpose only.