Tuesday, 11 December 2007

Leveraged downside trade - Selling FTSE through options

Looking outside the US, it is clear that their are many places that have issues. One of the most obvious is the UK, where despite the property market only recently topping out, they have still had a bank run on one of the major mortgage lenders. Property values there are even more stretched than the US, affordability is now being questioned, the market has fallen for 3 months in a row, and the Bank of England has just cut interest rates DESPITE HIGH INFLATION on fears the credit crunch is about to really bite in the UK. The FTSE has been a pretty poor performer over the last year, up around 7% whilst the DAX, the German main index, is up 24%. However I think this is because of all the downside risk that has existed within the UK property market, and hence the consumer and the economy.

1y Chart of FTSE 100

1y Chart of FTSE versus DAX

So putting this together, I am pretty comfortable taking a short bet in the FTSE. I'd like to express that in the following way:
Selling £5/point of 6400 Feb call at 348
Buying £20/point of 6100 Feb put at 87.1

So for flat premium, I can leverage 4 to 1 through selling an In-The-Money (ITM) call and buying an Out-The-Money put. I am fairly comfortable selling an ITM call as I expec the index to drift downwards for the next couple of months anyway. And I want the leverage because I think there is a decent chance of a near-term fall down to 6000 as fears about the economy are heightened. Also, the FTSE had a good performance in the past on M&A, which must be substantially reduced now the ability to obtain leveraged credit has all but disappeared.

You like it?


(Just an admin point, the option pricing in my spreadsheet is my model's estimate although should be close to market levels...I need to manually put in vol numbers, so just need to keep an eye on that over time)

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