As I've discussed in recent blogs, I've been using a three-legged spread to provide protection for my iron condor portfolio. No one has suggested a name for this type of trade, so I've decided to refer to it as a kite spread.
Example 1: The C3 Kite
Buy 1 XXX Mar 300 call
Sell 3 XXX Mar 320 call
Buy 3 XXX Mar 330 call
This is a call spread, so it's has the designation 'C'
The ratio is 1 x 3, and has the designation '3'
Example 2: The P4 Kite
Buy 1 ZZZ Jul 420 put
Sell 4 ZZZ Jul 390 puts
Buy 4 ZZZ Jul 380 puts
These are puts and the ratio is 1: 4. Thus, it's a P4 Kite.
Constructing the kite.
- Decide whether you are buying call or put protection
- Select strike price of option you want to buy
- Choose the spread to sell
- Decide how many spreads to sell
The number of spreads sold is determined so that the single long option is worth as much (or more) than the spreads are worth at their maximum value. In other words, if you sell four 10-point spreads, they can be worth $4,000. Thus the option bought is 40 points closer to the money than the long leg (the wing) of the spread.
In example 1 above, the 330 call is 30 points higher than the 300 call and the you sell three spreads (yes, you can always choose to sell fewer).
In example 2, the 420 put is 40 points from the 380s, and you can sell up to four spreads for each 420 put purchased.
I think of the kite spread as a long option (call or put) that grows in value as the market moves. At the end of the kite there's a weight (the sold spreads) that can temporarily make it difficult for the kite to soar. But, if we catch a good wind, the kite can become more and more profitable.