From the December/January 2013 issue of Futures Magazine • Subscribe!

How to trade ETF volatility

Another way to reduce the risk of a short put exposure is a put ratio spread. Investors can profit from a positive skew by adding at-the-money put options on the same underlying to the existing short out-of-the-money option position. The analysis in this case turns from one implied volatility number to the pair of at- vs. out-of-the-money volatilities (see “Skew analysis”).

The ratio of long at-the-money options vs. short out-of-the-money options can be adjusted to obtain a premium-neutral or delta-hedged position. In those cases, the number of puts to be shorted is, of course, higher than the long at-the-money put position, as both the premium and the delta are lower for out-of-the-money options. 

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