Index Spreads

Creating Index Spreads - Cash Versus Futures markets

When evaluating spreads, especially those with more than 2 legs to the strategy, what you may see as a great trade isnt always what you get. In the futures market, you have a better chance of being able to make a profit on a trade such as a butterfly or condor. Commissions on future options are usually less than half those of stock options and when you look at the leverage factor the differences are really seen. Lets take a look at 2 scenarios:

S&P Futures Condor

Buy 1 SP 955 Put - 13.50
Sell 1 SP 960 Put - 17.25
Sell 1 SP 970 Call - 17.25
Buy 1 SP 975 Put - 12.50

Credit of 8.50
Risk - 1.50
Reward - 8.50

Lets add in slippage of 1.00 to this spread

Now your risk is 2.50 and your reward is 7.50. Still a good risk / reward trade.

Your commissions on this trade are now $30 per round turn per contract. $30 x 4 = $120 in commissions or another .25 cents in commissions added to the spread. Now the trade risk reward after commissions looks like this:

Risk after commissions - 2.75
Reward after commissions - 7.25

Still looks pretty good for a strategy in a non moving market.

NOW - lets look at it again using S&P Cash Market.

S&P Cash Condor

Buy 1 SP 955 Put - 13.1/2
Sell 1 SP 960 Put - 17.1/4
Sell 1 SP 970 Call - 17.1/4
Buy 1 SP 975 Put - 12.1/2

Credit of 8.50
Risk - 1.50
Reward - 8.50

Adding the same slippage as the futures trade, our risk becomes 2.50 and our reward becomes 7.50. Commissions, however, are a bit different. An average discount broker will charge about $45 for each options transaction, both to enter and exit the trade. Lets add them up and see what commission would cost for this trade.

$45 x 8 (4 to enter and 4 to exit) = $360

This would represent about .75 in commissions for the cash trade. The new risk / reward looks like this:

Credit after commissions - 6.75
Risk after commissions - 3.25
Reward after commissions - 6.75

Using the futures markets can yield 10% more in after commission profits to this trade and can cut the risk after commissions by 16%. Obviously it can be done in both markets, but you need to take in account the slippage and commissions and weight them in your decision. Taking the time to view all risk and reward positions can help maximize your profit potential and keep the income flowing.

Good trading!