Options Trade of the Day: A Ross Stores Vertical Ratio Put Spread


Shutterstock photo

Shares of Ross Stores Inc. ( ROST ) are trading nearly 1% higher today, as the stock continues to consolidate its recent gains into support in the $70-$70.50 region. ROST was catapulted above this region due to buying momentum in the wake of better-than-expected fundamental data released on Feb. 3. Despite the quick trip higher, ROST has stalled after tagging a fresh all-time high of $71.93 on Feb. 14. What's more, the recent drop in momentum has sparked a round of speculation in the options pits, with traders turning toward put options.

 Daily ROST Chart with 10-Day and 20-Day Moving Averages

Overall, more than 6,100 ROST puts have changed hands, with options traders centering heavily on the March 70 strike. While digging through ROST's put volume, I ran across a block of 2,000 contracts at the March 72.50 strike, which traded on the New York Stock Exchange (NYSE) for the ask price of $2.95, or $295 per contact. I found the other leg of this spread on the popular March 70 put, where 4,000 contracts traded for the bid price of $1.50, or $150 per contract. Given this data, we could be looking at the initiation of a vertical ratio put spread, or a credit spread , on Ross Stores Inc.

ROST option volume details

The Anatomy of a Ross Stores Vertical Ratio Put Spread

Breaking down this vertical ratio spread, the trader would have purchased 2,000 March 72.50 puts for a total outlay of $590,000 -- (2.95 * 100) * 2,000 = $590,000. Meanwhile, the trader also sold 4,000 March 70 puts for a credit of $600,000 -- (6.43 * 100) * 4,000 = $600,000. Combining these two legs results in a net credit of $10,000 -- $590,000 - $600,000 = $10,000.

ROST vertical ratio put spread details

The maximum profit on this vertical ratio put spread is achieved when the underlying stock falls to the sold strike, which would be the 70 level in this case. However, since twice as many March 70 puts were sold, this spread position will begin to lose money after ROST moves below $70 per share. Once ROST breaches this region, only half of the 4,000 sold March 70 puts are hedged by the 2,000 purchased March 72.50 puts. As such, the trader will begin to lose money on the unhedged portion of those sold March 70 puts as ROST moves lower. Below is a chart for a rough visual representation of the trade's profit/loss scenario:

ROST vertical ratio put spread profit/loss chart

Implied Volatility

While a standard vertical put spread is not greatly impacted by rising implied volatility, a spike in implieds could be detrimental to a ratio spread. Since the trader has sold more contracts than he has purchased, rising implied volatility on these options would negatively impact the position, as it would make it more costly to repurchase these contracts should the trader need to do so. At the time of the trade, implieds for the March 70 put arrived at 24.76%, while the implied volatility for the March 72.50 put rested at 26.68%. ROST's one-month historical volatility arrived at 25.40% as of the close of trading on Tuesday.

The winter 2011 issue of SENTIMENT magazine is now available here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

All Rights Reserved. Unauthorized reproduction of any SIR publication is strictly prohibited.

This article appears in: Investing , Options

More from Schaeffer's Investment Research


Schaeffer's Investment Research

Schaeffer's Investment Research

Market News
Follow on:

Find a Credit Card

Select a credit card product by:
Select an offer:
Data Provided by BankRate.com