Strategy

Index Mat

Type of Strategy

investing

sentiment

bullish, neutral, or slightly bearish

implied volatility

high iv preferred

description

The Index Mat is a specific application of a vertical spread established well below the market price of an equity index, generally the S&P 500.  While the strategy can be constructed with either puts or calls, puts are preferred due to higher liquidity and lower expected transaction costs.  Index Mat spreads are generally established for time periods of 180-720 days.

Investors executing an Index Mat spread in the S&P 500 may commonly choose either SPX or SPY options based on their preference and specific use.  When choosing the SPX version, a taxable account may be utilized to take advantage of the preferential tax treatment of the section 1256 contract.

Index Mats spreads benefit from high implied volatility environments, as the increased option premiums allow the Mats to achieve either higher returns at the same level, or equivalent returns at more distant levels below the current index price.

Set-Up

Investors should only establish Index Mat spreads at strike prices in which they believe a strike breech is nearly impossible in the spread expiration cycle.

At an index price level that the investor has extremely high confidence in holding through a time period of 180-720 days, the investor sells a vertical put spread.

There is generally no management required for this position.

If a very significant market crash occurs that begins to threaten the short put spread as expiration approaches, the investor may roll out or roll out and down the spread to protect capital at the cost of reduced yield and increased time in the investment.

Index Mat – SPX

example – SPX

Index Mat – SPX – @ 3975

   – 357 DTE     IV = 16

   – Short Put at 2800 (-29.6%)

   – Long Put at 2700 (-32.1%)

   – Return (annualized) = 9.4%

1) SPX currently at 3,975

2) Investor has extreme confidence that the S&P 500 will close above 2,800 at the end of one year

3) Sell a 357 DTE, DOTM vertical put spread (2800/2700) for $9.40

4) Net premium received = $9.40

5) Max profit = $9.40  Max loss = $90.6

6) Breakeven point = $2790.6

Management

If a significant market crash occurs, investor should look to roll out and down, as available, to protect capital.

As a risk defined strategy, the risk management priority is established at order entry.

Considerations

Note that SPX is a Section 1256 contract with preferential tax treatment.  SPX contracts offer preferential tax treatment on holdings of less than a year’s duration.  Beyond a year’s duration, the tax advantages of the SPX contract are lost, and may even become a drag on net return compared to other alternatives.

Note that an Index Mat is only one alternative for investing cash saved by utilizing option strategies.  There are a wide variety of opportunities, many of which may hold better risk/reward profiles, including government bonds, corporate bonds, municipal bonds, money market accounts, CD’s, debt instruments, certain dividend investments, real estate, etc.

The Index Mat is presented as a single opportunity that may be employed through the use of equity options.

example – SPY

Index Mat – SPY – @ 396

   – 357 DTE     IV = 15

   – Short Put at 280 (-29.3%)

   – Long Put at 270 (-32.8%)

   – Return (annualized) = 9.4%

1) SPY currently at $396

2) Investor has extreme confidence that the S&P 500 ETF will close above $280 at the end of one year

3) Sell a 357 DTE, DOTM vertical put spread (280/270) for $0.94

4) Net premium received = $0.94

5) Max profit = $0.94  Max loss = $9.06

6) Breakeven point = $279.06

Management

If a significant market crash occurs, investor should look to roll out and down, as available, to protect capital.

As a risk defined strategy, the risk management priority is established at order entry.

Considerations

Note that SPY is not a Section 1256 contract.  However, if the spread was established for a period greater than 365 days, the spread could be treated as a LTCG.

Note that an Index Mat is only one alternative for investing cash saved by utilizing option strategies.  There are a wide variety of opportunities, many of which may hold better risk/reward profiles, including government bonds, corporate bonds, municipal bonds, money market accounts, CD’s, debt instruments, certain dividend investments, real estate, etc.

The Index Mat is presented as a single opportunity that may be employed through the use of equity options.