This article will focus on comparing a long put versus a vertical put spread.
In a recent Options class at our Minnesota center, we looked at the general market and noticed that it was approaching previous supply zones. Based on past price action performance, we forecasted that there was a high probability that the markets might fail to break to the upside and consequently roll over. So next we looked at the (I.V.) implied volatility of IWM, the exchange traded fund that tracks the Russell 2000. After checking out the current I.V. reading against its 52 week historical volatility high and low, the conclusion was made that the majority of the Exchange Traded Funds (ETFs) that are tracking the general US market low I.V.
Historical V. 52-week High
Current I.V. Index mean
Historical V. 52-week Low
57.10%
20.88%
13.65%
Figure 1: Current IV for the IWM as of 8/7/2012
Low I.V. means that we should be a buyer of options. The fact was that I.V. was not necessarily at its lowest reading but just inside its lowest range, which means that we could do either a simple option strategy such as a long put or a more complex strategy such as a vertical put spread.
PART I: A Long Put
Before we explain how the more complicated vertical put spread works, we will go slowly over the long put. Figure 2 below breaks down a put option into pieces.
At the time, the IWM was trading at $79.94 per… Continue Reading