Selling Vertical Spreads in Zero Days to Expiration Options

[00:00] [Music] we're going to talk about selling vertical spreads in zero DT options

[00:13] butterfly yesterday a butterfly is just two vertical spreads right one long one short of course of course but and and there's lots of variations of vertical

[00:25] spreads we're going to focus especially people that trade s you know the SPX to do one lot naked strangle in the SPX is almost um 78 or 80 000 I don't remember yeah

[00:39] pretty close to do a one lot naked put one lot naked call or one last strangle it's like it's almost eighty thousand dollars it's just under 20 of the price of the underlying which is four thousand so it's around 80 000 bucks so

[00:54] so that's a little bit too much money for most people and I you know and myself included I just don't even want to waste that much money just tying it up so you can improve the capital requirements

[01:08] dramatically by normalizing kind of the strategies and by using vertical spreads hundred dollars to a thousand dollars whatever it is and so selling vertical spreads buying vertical

[01:23] dollars on it and I know I know it's a different topic but I do a lot of these on my podcast when I'm doing like a broken wing butterfly in SPX I use five

[01:35] thousand dollars which is closer to the buying power of spy right to get it into a larger product like SPX yeah because spy is one tenth the size of SPX so like most people you know use use spreads and spreads trade you know five or ten cents

[01:51] as a half a penny or one penny off mid-price so it's it's very fair let's so selling vertical spreads is a way for Traders to bet on a directional move in

[02:06] the market while also winning if the stock stays the same by expiration approximately one-third the width of the strikes we're just giving you know we

[02:18] had to Ballpark this somewhere so if we were doing spy for example we did a short we used spy for this example we short vertical spread it'd be something like um selling the 399 put buying the 390

[02:32] put um and in June expiration we'd collect a credit this is nine dollars wide we collect a credit of 217. your max loss is the inverse between nine and you subtract 217 from 900 and your max loss

[02:47] is 683 and your probability of profit which is purely theoretical here is 62 right that all makes sense that's that's old school let's go to the next slide

[03:04] so in the zero DTE the spreads that get you to one-third the width of the strikes are usually one dollar wide and the short strike is usually one dollar out of the money in the Spy now we don't trade a lot of one dollar wide spreads

[03:19] but for the purpose of showing this because we want you to be able to take this and extrapolate out and look think about this in in xpx SPX terms which might be ten dollars wide okay sure sure so if you did the 40 if you sold the 404

[03:34] Port puts and bought the 403 puts in the zero DTS you'd receive a net credit of two of 27 if you were doing this in the SPX it would be 270. all right so in the

[03:47] one dollar wide spread you're risking 73 dollars in the in the SPX it would be the equivalent of 730 and your probability of pro probability of profit is exactly going to be the inverse or about 66 percent

[04:02] okay let's go to the next slide so what happens to the value of these spreads in the zero dtes if the stock moves in your favor if it moves against

[04:14] you or if it doesn't move at all that's the million dollar question everybody wants to know right of course yes okay let's go to the next slide

[04:26] that's why we do the research so we just study we sold put vertical spreads with the 35 Delta short leg and the 25 Delta long leg okay we did them about ten dollars wide because that gets you to about a third of the width of strikes

[04:40] we sold in the zero DTE and we also did it in the 45 day DT so you can see the difference okay okay we recorded the p l of the spread as a percentage of the net

[04:53] Credit in the first half of the day if the Spy moves by two dollars one dollar unchanged down a dollar or down two dollars now the reason we did this is because in most days that's kind of like you know a

[05:08] reasonable range right now given we're implied volatility is Right a subject to change right it could get tighter it typically can get wider but I mean you gotta look at the implied volatility let's go to the next slide

[05:21] so despite starting at the same Delta and this is this is the first really important takeaway spikes starting at the same Delta zero days to expiration spreads see ten percent see ten times not 10 10 times

[05:38] the directional exposure then 45 DT spreads because the gamma risk so when Tony asked me this morning why did you take that spread off it's because I 10 times the directional exposure that I would on a normal 45 Day Option

[05:59] I mean the reason we trade 99 of our trades in 45 day out um 45 day spreads is because we don't want 10 times the risk we already have enough risk right right just understanding that you have 10x the risk

[06:14] when you do zero DTS versus 45 days TT now the Theta Decay plays out the same in the zeros and there is basically no Theta Decay for the first few days in

[06:27] the 45 DT options so the the argument here again we're just showing you the difference in Risk so when we do something and and this is the p l of a short put spread okay ten dollars wide in the spy and we're comparing the zero

[06:42] DTE to the 45 day DT right zero DT uh up stocks up two dollars seventy percent versus seven percent of 1.40 versus three unchanged 25 verse 1 down um 15 first three percent and down two

[06:59] dollars is down 111 per seven percent um again we're just averaging this to about being about 10x difference so so now you know what the risk is when

[07:12] somebody says hey what what's my risk in the zero DTS if I'm short spread well your risk is you know obviously your risk is defined so your risk is whatever your risk is going to move at 10 times the speed that it would move in a 40 day

[07:28] five Day Option okay now but hold on one second here so and 45 days just the column of the percentages on the right hand side there

[07:40] now you're looking at a percentage of being unchanged in zero day options is 25 now look at the disparity it's a multiple of each other on a dollar lower or two dollars lower versus up a dollar two dollars do you see any

[07:57] Edge value bad in the in in those numbers um I'm not sure what I'm not sure where you're going with this but no I mean not

[08:11] really I mean um well it looks like the risk of a full one and a half times as much the intraday

[08:24] right like I mean look at how fast they they move I mean a one dollar down move is 15 versus basically nothing three percent on a 45 day yeah

[08:36] good it's 10x it averages to 10. 10x right right yeah it averages to 10x let's go to the next slide so the zero DT spreads now here's the other thing

[08:52] they have 1 8 the credit because we're giving you some really juicy takeaways here the zero DT spreads only have 1 8 the credit of the 45-day

[09:04] spread but they carry 10 times the directional exposure as a percent of the credit so it just takes a one lot of a zero DT spread to match the dollar exposure of one 45

[09:21] day spread which is pretty interesting um so we we put it out here we kind of spelled it out but the average net credit for a short 35 um Delta short put and a long 25 so it's

[09:37] 10 10 Deltas wide on the spread um the zero DT is twenty seven dollars the 45 DT is um 217 so so basically you collect

[09:50] play out you collect 1 8 the credit but you take 10 times the gamma risk now you get paid for it the percentage of the credit received and a percentage

[10:04] of the credit received yes dollars themselves percentage the dollars themselves are going to be the same it's the percentage of the credit received go go but as a percentage of the yeah the percentage of the credit received

[10:20] you take 10x the risk you receive 1 8 the credit but you get paid in a day sure sure you know so that's the risk reward and feast and famine the

[10:32] challenges you you can't afford to be wrong oh is that it yeah so for all the for all the directional Geniuses this is if you're a directional genius this is amazing it's amazing you've been waiting

[10:47] this your whole life I mean it gives you it gives you you know clearly gives you more optionality but if you wanted to be able to you know

[10:59] to be able to put the put some context around the risk that's what it is 10x the direction you know let me go once so let me go one step further with you let's say I'm a one line ten dollar wide spy Trader that's my

[11:16] that's my wheelhouse fits my account size and everything else like that these zero day options should I be doing a ten dollar wide zero Day Option One contract or since the

[11:30] the the product itself adds almost 10 times as much risk should be doing like a five dollar wide one contract spread in zero day or some multiple of that that's what I'm trying to ask the problem with zero days

[11:45] I think you have to be wider otherwise I don't think you give yourself enough room like like if you did it if you did a 10 why today I mean unless you were obviously right you know we're up 40 we're 4X that move yeah yeah no I get

[12:01] well if I'm looking at a zero day yeah yeah you're right five dollars ten they're basically worthless options yeah

[12:16] um okay crazy let's go last slide I love this takeaways one eighth of credit ten times three not ten times the speed of the risk let's go next slide I just like the context it just helps me

[12:31] explain things so credit spreads in zero day options are roughly eight times cheaper than the same spread in the long dated cycle however because the same spread carries 10 times the direction of exposure you only need one zero day

[12:45] spread to match the risk of 145 day spread on a day-to-day basis well I think it's kind of answering my question for me right there there you go

[12:58] it's basically one to one mm-hmm it's a good study I'm gonna have to absorb it I'm gonna have to do a lot of one day spreads that's the bottom line let's say a quick 90 second break and

[13:12] come back we got more tasty Life coming up next with oh joy you upright than mine Mr Scott Sheridan take the trade world headquarters