Jits last weekend in the weekly saturday review we publish on www.EQDerivatives.com, we wrote an NDX 1×2 call spread that hit the band in the final minutes of trading on Friday June 17th. Digging through NDX trades, we came across fourteen similar 1×2 NDX spreads. These spreads use both put and call options and were initiated with NDX at 11266 a few minutes before the 4:15 closing time for NDX options. The majority of these trades were 1×2 call spreads, but these trades represent two different expirations (June 24 and July 15) while the three sell spread trades use the June 24 options. Finally, we released fourteen different executions, but several were identical except for size, so we’ve grouped them below into nine positions.
June 24 Appeal Dismissal
The chart below highlights each of the 1×2 call spreads using the June 24 call options. All four were launched with no net credit or debit, just the commission cost, so they are not 100% free.
Earnings charts based on Friday, June 24 closing prices appear below for each of these trades. The first trade uses the 12300 and 12550 calls. This puts the breakeven point at 9.2% and 13.6% if held until expiry.
The second trade bought 1 call at 12,500 and sold 2 calls at 12,800, with breakeven prices at expiration between 10.9% and 16.3%.
The third 1x2call spread on June 24 combines the 13150 and 13600 calls. The net results of this trade imply breakevens of 16.7% and 24.7%.
Finally, the fourth 1x2call spread uses the 13400 and 13850 calls placing the breakeven point between 18.9% and 26.9%.
These four trades were placed with four trading days remaining until expiry, due to the holiday shortened week. We decided to examine how many times, over a four-day period, NDX closed inside breakeven points for each of these trades. The table below details this data.
This chart uses Nasdaq-100 trading data from October 1985 to present. This includes 9,251 rolling observations over four days. The “In Range” and “% In Range” numbers take the maximum close during that four-day period to determine that the trade was in-the-money at some point in the life of the trade.
Note that the odds are less than 1% for each range and for the 18.9% to 26.9% range, only once did the NDX close in that range in a four-day period. Not on the table, but probably interesting, is the biggest move in a four-day window, a gain of just over 21% in early June 2000.
Before moving to the July 15th buy spreads, we decided to price these four trades based on the end-of-day bid and ask prices on Tuesday, June 21st. To determine an exit trade, we used the midpoint of the bid for each option and then gave ten cents. This price assumption is in line with Friday’s execution trades.
Tuesday was a strong day for the Nasdaq-100, with the index up around 2.5% on the day. Although the options for each of the spreads are still significantly out of the money, the two 1×2 spreads that are less out of the money could be taken out for small profits. The two farthest from the currency spreads would take a loss if they exit, but that could change if NDX records a few stronger days this week.
July 15 Appeal Dismissals
Two 1×2 buy spreads using the July 15 options were both initiated with small credit, which most traders find more attractive when the sweet spot of profitability involves a large move.
Both trades bought one NDX call July 15 14200, with the first trade in the table above selling two NDX calls July 15 14600 resulting in a net credit of 0.30. The lower strike and upper breakeven points for this trade are between 26.0% and 33.1%.
The second spread sold the July 15 NDX call 14650 against buying a July 15 NDX call 14200 resulting in a 0.10 credit. The key price levels for the second trade are between 26.0% and 34.0%. Using the phrase breakeven in this case would be inaccurate because anywhere below the highest strike these trades would be profitable.
The July 15 expiration is an old-school standard third Friday, meaning these are AM settled contracts. Based on this and two holidays, there are 17 trading days between trade execution and expiration. The probability of NDX landing between these two significant levels is very low. We ran historical NDX performance covering 17-day rolling observations and found ten instances since October 1985 where NDX was within ranges for each of these longer-dated call spreads.
June 24 Put Spreads
The third category of 1×2 spreads used ends on Friday June 24th. Each of these three trades took a credit, so even if the Nasdaq-100 continues to rise, each would make a profit.
The first trade bought 10500 puts and sold 10225 puts. This resulted in a credit of 1.50 for each spread. The trade starts to gain more than this 1.50 if the NDX is below 6.8% and above 11.7% there is a risk of loss.
The second 1×2 put spread bought the 10300 put and sold the 10000 puts with a credit of 1.19. This trade begins to benefit from NDX weakness if there is an 8.6% loss and the downside breakeven occurs down 13.9%.
Finally, a third put spread 1×2 bought the 10100 put and sold the 9750 puts taking a credit of 0.37. The long strike of 10100 put is 10.3% lower than NDX and the breakeven point is down 16.6%.
Each of these sell spreads would increase in value based on a significant drop in the Nasdaq-100, although the range of incremental earnings for each is well within historical norms. In fact, these sell trades should be closely watched and profits taken if NDX begins trading where the trade can be exited at a credit adding to the income received when the trades were executed.
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