Exploit S&P option pricing via ratio backspreads
The guest argued that investors can exploit the overpricing of moderate out-of-the-money options by structuring trades that combine written 25-30 delta puts with multiple purchased 5-10 delta puts.
The argument
Moderately out-of-the-money options are structurally overpriced due to persistent demand for protection, whereas deep tail options are statistically unpriceable and often cheap. This ratio backspread structure offers a way to capture the volatility risk premium while maintaining positive convexity in a crash.
The thesis, stress-tested
✓ What validates it
- ✓A sudden, sharp downward repricing in the S&P 500
- ✓A spike in implied volatility for deep out-of-the-money puts
▸ Risks discussed
- ▸Time decay (theta) if the market trends down slowly without a sharp shock
- ▸Requires active management as the option Greeks change over time
Hear it yourself
"That's almost where I wanted to begin. It's called second leg down. And in some ways, it seems that it is a reflection of just how you have learned to think about markets and specifically about vol and using option related instruments in a portfolio. Tell us a little bit about how you came to write the book and then the big picture thrust of what's in there. Well, I kinda stumbled into the tail risk space with a long vol space in 2007, which was an interesting time to stumble into it, so to speak. I ran a couple of substantial mandates."
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