Option Strategies Details

A trader who wants to speculate on a decrease in volatility and a neutral to small decrease in price can open a Put Frontspread. The trader receives a small credit for opening the position.

Suppose stock XYZ is trading at $133. You forecast a decrease in volatility and a neutral to small decrease in XYZ price.

You open a 1x2 $130 / $125 Put Frontspread (buying the $130 Put for a $4.25 debit and selling two (2) $135 Puts for $2.60 each) for a $0.95 credit to express this view. Your breakeven high XYZ price at expiry is any price above $130 (since you entered the position for a credit and all contracts would expire worthless). The low breakeven price is more complex to calculate but adheres to this formula:

Strike Price of Short Puts - (Width of Spread / (N - 1)) - Credit Received

Where N is the number of Short Puts whose credit is used to buy the Long Put.

The low breakeven for this Put Frontspread is $125 - ($5 / (2-1)) - $0.95 = $119.05. However, since the time component of your trade plan may not since the time component of your trade plan may not extend all the way to expiration you should be prepared to to close at a variety of XYZ prices as the market value of your 1x2 $130 / $125 Put Frontspread changes.

The max loss on this position at expiry is theoretically very high but capped, since XYZ price can only decrease to zero. The max gain of a Put Frontspread occurs at expiry if XYZ price increases to the exact Short Put strike, where you would make the width of the spread plus the credit received ($130 - $125 + $0.95 = $5.95 in this example). Since the loss on a Put Frontspread is theoretically very high (but not technically unlimited), this structure carries a high "risk of ruin". The unlimited loss can be mitigated by buying a further OTM Put(s), which morphs this structure into a Long Put Broken Wing Butterfly; unfortunately, this turns the trade into a debit transaction rather than a credit transaction and removes the gains associated with an XYZ price increase.