Kite Spread: Protection for Credit Spreads

Mark

In "Rookies" you have a chapter on insurance. You suggest using a
front month long put to cover 2nd or 3rd month put credit spreads. The
Kite appears to be using the same month long put along with the credit
spread. I don't see how the credit spreads can pay for the long put
using the 4×1 ratio? What am I missing?


Thanks,

Greg

***

You are not missing anything.

1) I do believe owning front month insurance is more effective than owning same month insurance – except when IV is low and you want to be long vega.

2) It is still uncomfortable for many traders to own options that expire before positions they are supposed to be protecting.  The kite overcomes that problem.

3) The credit spreads DO NOT pay for the long option in the kite spread. 

The idea is to sell the credit spreads to enable the investor to purchase an option with a very useful strike price – at a reduced cost.

4) One drawback for kites – I have not yet discussed it (but it's all in the eBook that I'm writing) – is that they are not designed to be held through expiration.

For traders who prefer to own iron condors to the bitter (or not so bitter) end, kites are not the best adjustment vehicle.

But for those who plan to exit early (two to four weeks early), this is an ideal insurance policy.

I'll post more on kites, but have no specific schedule.

536

2 Responses to Kite Spread: Protection for Credit Spreads

  1. Don 12/02/2009 at 7:58 AM #

    Hi Mark, this is always in interesting subject-equivalent positions.
    S=C-P when we have slightly bullish tendency covered calls is effective is there a reverse trade using the above equations if slightly bearish?
    Say you short 100 shares of stock (or sold a call)if you sell puts against it is that the equivalent of buying a call and selling calls?
    Just trying to see if I yet completely grasped the interchangeability of these.

  2. Mark Wolfinger 12/02/2009 at 8:02 AM #

    You can write covered puts: Short stock and short put.
    This works to the downside the same way a covered call works to the upside.
    But this position is equivalent to selling a naked call option – and there is really no need to trade two legs when one will suffice.
    However, your broker may see it differently. Many do not allow the sale of naked calls and you would be forced to either sell a call spread (not as bearish, but safer), or write a covered put.