Last time we looked at putting on credit spreads on ETFs in order to potentially bring in additional income in ETFs (to read Part 1 of our article, click here.).
Today, let’s look at a more aggressive and potentially more profitable way to take in additional income. This is done with Ratio Spreads.
Instead of me writing a long tutorial on Ratio Spreads for those of you who are unfamiliar with it, I’d suggest you do a search and you’ll see many good options sites that do a good job describing what they are. What I’d like to do here is show you how to potentially use them when we have our ETF signals.
Let’s go back and use the SPY example from yesterday. Let’s assume the SPY is at 77 and we have a sell short signal today. Yesterday we learned we could put on a credit spread by selling the 77 calls and protecting ourselves by buying an equal amount of 79 calls.
In a Ratio Spread, you would be more aggressive. You would potentially sell two or three, 77 calls and buy one 79 call. If you’re wrong , you’ll be fully protected on one of your 77 calls and partially protected on the remaining piece as the 79 call will start gaining value faster as it moves further in the money. A more conservative version of this is to sell three 77 calls and buy two 79 calls. thereby gaining greater protection.
The key to understanding this is that the lower the ratio, the lower the risk and lower the potential gains. The higher the ratio, the greater the risk and the higher the potential gains. As I mentioned yesterday, this strategy is especially appropriate with high probability set-ups (those you believe will be correct at least 70% of the time) in highly liquid ETF options like the SPY’s.
Options Spread trading is an excellent strategy to use to bring in additional income in ETFs. If you decide to go the Ratio Spread route, please make sure you understand the risks involved because they are greater than the risks with credit spreads.
On Monday we’ll look at how to bring in income in ETFs that are moving sideways.
Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.