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I’ve been thinking a lot about Nassim Taleb’s story of Nero Tulips in “The Black Swan.” Here was a trader who spent most of his career looking foolish, losing small amounts on crash insurance, only to make it all back (and more) in a single market collapse. What fascinates me is how he understood something that most miss: in markets, the rare catastrophic events might matter more than all the small daily moves combined.

This idea led me to Spitznagel’s “Safe Haven,” where he explores a challenge I’m wrestling with: How do we protect against these rare but devastating crashes without bleeding money while we wait?

The traditional approach seems straightforward enough. Buy put options, like buying insurance for your house. Pay your premium, and if the market crashes, you’re covered. If it doesn’t, well, at least you can sleep at night.

But there are two major problems with this approach.

First, I’m finding the math to be brutal. On my $100,000 portfolio, basic put options would cost 1-2% every month. That’s $12,000-24,000 per year just for protection. Over a decade without a crash, I’d spend more on insurance than I’m trying to protect in the first place.

To find a solution to this monumental problem, we need to reduce the costliness of risk—specifically the costliness of losses—and do so in a way that does not end up costing us even more. In other words, we need a cure that is not worse than the disease. Risk mitigation must be cost‐effective.

-Mark Spitznagel – Safe Haven: Investing for Financial Storms

Second is the timing challenge I keep running into. I understand I should buy insurance when markets are calm, and options are cheaper. But what about when I need to adjust or add more protection? That’s where I get stuck. During market turbulence, when I’m most tempted to increase coverage, put options become prohibitively expensive. It reminds me of trying to buy hurricane insurance when there’s already a storm on the horizon – technically possible, but at a painful premium.

In my search for solutions, I’ve come across two interesting strategies that might help solve these problems: the Back Ratio Spread, and the Risk Twist Spread. Let me share what I’m learning about them.

Understanding the Back Ratio

Let me start with the Back Ratio Spread – it caught my attention because it takes an interesting approach to the protection problem. Instead of just buying insurance, it suggests being both the insurance company and the insurance buyer at the same time. Here’s how it works:

First, you sell one put option closer to the current market price. This is like being the insurance company – you collect some premium upfront. Then, you use that money (and a bit more) to buy two put options further below the market price. This is your insurance protection.

Think of it like making a deal with your home insurance company where you agree to cover minor damage yourself in exchange for extra coverage against major disasters.

Let me show you how I’m thinking about this with SPY trading at $400:

• I sell one put at $390 (playing the insurance company role)
• I buy two puts at $370 (getting my protection)

The interesting part is how these options work together. When I sell that $390 put, I’m taking on the obligation to buy SPY at $390. But by buying two $370 puts, I get the right to sell SPY at $370 twice. So when the market really crashes, that extra put option becomes pure profit potential – it’s not offset by anything.

It’s like having an insurance policy where I agree to handle moderate damage (down to $390), but in exchange, I get extra coverage that kicks in during a real disaster (below $370).

I’ve been playing out different scenarios in my head to understand how this works:

Scenario 1: Small Drop

If SPY drops to $385:

• The put I sold at $390 is now in-the-money, losing $5
• My two $370 puts are still out-of-the-money, worth very little
• I’m looking at a small loss here

Scenario 2: No Move

If SPY stays around $400:

• The put I sold at $390 expires worthless
• My two $370 puts expire worthless
• I lose only the initial cost of the spread

Scenario 3: Big Drop

If SPY crashes to $350:

• The put I sold at $390 loses $40 ($390 – $350)
• But my two $370 puts each gain $20 ($370 – $350), so $40 total
• The two long puts offset the short put, plus I keep the initial credit from setting up the spread

This strategy made sense to me at first – I’m giving up some upside by selling the higher strike put, but getting extra protection from those two lower strike puts. But then I noticed something odd about how these puts are priced – something traders call “skew.”

Understanding Option Skew: The Hidden Cost

Here’s something that caught me by surprise when I started looking at put option prices. It’s a bit like car insurance – in my quiet suburb, insurance is pretty cheap. But in areas with lots of accidents, rates are much higher. The same thing happens with market protection and understanding this changed how I think about these strategies.

When I started looking at different ETFs, I noticed something interesting about how their protection is priced. Let me share what I found when comparing SPY and QQQ. To keep things simple, I looked at both when they were trading at $100.

For SPY, which is what big institutions typically use:

• I saw a put option at $100 costing about $2
• But the interesting part was the $90 put – it still cost $1.50
• I remember thinking, “Why is this put still so expensive when it’s much further from the current price?”

Then I looked at QQQ:

• The $100 put also cost about $2
• But the $90 put was only $1.10
• The difference in pricing caught my attention

This pricing pattern, is referred to as “skew.” There seems to be this collective worry about crashes – so much so that people are willing to pay premium prices even for protection far below the current price. It reminds me of how hurricane insurance prices spike when everyone tries to buy at once. QQQ shows this pattern too, but I’ve noticed it’s not quite as extreme.

This discovery about skew made me rethink my approach to the Back Ratio strategy. Since I’m buying two put options below the market price, their cost becomes a real issue when skew is high.

Before exploring alternative strategies, I wanted to find simple ways to check these skew levels myself. I found three approaches that don’t require fancy tools:

1. I look at my broker’s option chain and compare put prices at equal distances from the current price. If the downside puts seem unusually expensive, that’s probably high skew.
2. Sometimes I check the CBOE Skew Index (ticker: SKEW). I’ve noticed readings above 150 often mean crash protection is getting expensive.
3. I developed what I call my “quick check” – I look at puts 10% below current price. If they cost more than half of what at-the-money puts cost, skew might be too high for a Back Ratio.

For example,

with SPY at $400:

• If a $400 put costs $6
• And a $360 put costs $4
• That’s high skew (because $4 is more than half of $6)

I recently looked at SPY when it was trading at $400:

• The $400 put cost $6
• The $360 put cost $4
• This told me skew was high because that $360 put was costing more than half of the $400 put

This kind of situation got me thinking about whether there might be a better approach when protection gets this expensive…

The Risk Twist Spread: What I Learned About Expensive Markets

While researching solutions for high skew situations, I came across something called the Risk Twist Spread. It builds on the Back Ratio concept I was already exploring, but with an interesting adjustment.

Let me share how I’m thinking about it using SPY as an example:

If SPY is trading at $400, the Risk Twist approach suggests:

• Buying 3 put options at $380 (slightly out-of-the-money)
• Selling 1 put option at $390 (closer to current price)
• Selling 1 put option at $370 (further below)

At first, this seemed more complicated than the Back Ratio, but I started to see the logic behind it.

Instead of buying just two puts like in the Back Ratio, this approach buys three puts but sells an extra one at a lower price. It felt counterintuitive at first, but I started playing out different scenarios to understand it better:

Scenario 1: Small Drop

If SPY drops to $385:

• My $390 put I sold would lose some money
• My three $380 puts would gain a little
• My $370 put I sold would barely move
• I might take a small loss or break even

Scenario 2: No Move

If SPY stays around $400:

• All the options would expire worthless
• I’d only lose what I paid upfront (and sometimes this strategy can even pay me to put it on)

Scenario 3: Big Drop

If SPY crashes to $350:

• Both puts I sold would lose money
• But my three bought puts would gain much more
• I could potentially make even more than with the Back Ratio

What I find fascinating about this approach is how it tries to use that expensive skew to its advantage. By selling that extra lower strike put when it’s expensive, I might actually reduce my cost of protection or better yet, get paid for buying protection.

Choosing Between Back Ratio and Risk Twist

After learning about both strategies, I found myself wondering when to use each one. Through my research and experimentation, I’ve noticed it seems to come down to three main factors:

1. Market Environment

Each strategy might work better in different market conditions:

• The Back Ratio seems to work better when I check skew and find protection reasonably priced
• The Risk Twist appears more useful when I see those expensive skew patterns we discussed earlier

It reminds me of seasonal insurance pricing – like how I might buy hurricane insurance in December when prices are reasonable but need to get more creative with coverage during hurricane season.

2. Cost Consideration

This is where I started questioning these strategies more deeply. Looking at the costs:

A simple put option at $380 might cost me $3.

When I look at the Back Ratio:

• Selling the $390 put brings in $5
• Buying two $370 puts costs $6
• Net cost is $1

For the Risk Twist:

• Selling the $390 put brings in $5
• Buying three $380 puts costs $9
• Selling the $370 put brings in $3
• Net cost is $1

This made me wonder: Why make things so complicated? If I can buy a simple put for $3, why create these complex structures that don’t seem to save much money and might actually increase my costs in some scenarios?

But we can see when these strategies might make sense. In high volatility environments, when put options become really expensive, these spreads might actually result in a net credit – meaning I get paid to put on the protection. This seems especially true when there’s high skew, where those further out-of-the-money puts I’m selling become particularly valuable.

So, while my initial examples showed similar costs, we will notice that in certain market conditions, these strategies might actually be much cheaper than buying puts outright – sometimes even free or better.

3. Protection Level

When comparing protection levels between these strategies, I’m starting to see some interesting patterns:

With a simple put option:

• I get straightforward protection but at a higher cost
• In high volatility environments, this cost might become prohibitive
• I might end up not buying protection when I need it most due to cost

With the Back Ratio:

• The protection isn’t as clean, but it might be free or even profitable to put on
• That short put at a higher strike actually helps fund the protection
• In high volatility environments, the strategy becomes more attractive

The Risk Twist seems particularly interesting in high skew environments:

• Those two short puts can generate significant premium when volatility is high
• The three long puts provide robust protection
• The structure might even pay me to take on the position

I’m beginning to understand why traders might choose these more complex strategies – they’re not just about saving money, but about making protection viable in expensive markets when simple puts might be impractical.

Strike Selection and Expiration

After understanding why these strategies might be valuable, my next challenge was figuring out where to place the strikes. Initially, I tried using simple percentage rules (like “5% below market price”), but I quickly learned this wasn’t ideal.

Let me share what I discovered by looking at SPY at $400 in two very different market conditions:

Calm Market (VIX at 15)

• A 5% drop to $380 might be a 15-delta put
• A 7% drop to $372 might be a 10-delta put
• The market sees these as relatively unlikely events

Volatile Market (VIX at 30)

• A 5% drop to $380 might now be a 25-delta put
• A 7% drop to $372 might be a 20-delta put
• The market is pricing in much higher probabilities of these drops

This comparison showed me why using fixed percentages could be problematic. The same 5% drop means something very different in calm versus volatile markets. That’s when I started learning about using delta instead of percentages.

Looking deeper into delta, I found some guidelines that started making sense:

For the Back Ratio, traders often suggest:

• Selling a put around 30-delta (meaning about a 30% chance it ends up in-the-money)
• Buying puts around 15-delta (about a 15% chance)
• With SPY at $400, this naturally led me to selling the $390 and buying the $375 puts

For the Risk Twist, the approach seems to be:

• Selling that higher put at 30-delta (same as Back Ratio)
• Buying the middle puts at 20-delta
• Selling the lower put at 10-delta
• This might mean selling $390, buying $380, and selling $370 with SPY at $400

What I like about using delta is how it automatically adjusts for market conditions. When volatility increases, these same delta levels will suggest strikes closer to the current price – exactly what you’d want when the market sees bigger moves as more likely.

Delta-based strike selection offers several key advantages:

The first is automatic volatility adjustment. When VIX is high, the same delta level suggests strikes closer to the current price. When markets are calmer, those strikes move further out. This eliminates the need for constant approach adjustments based on market conditions.

Another advantage is probability consistency. A 30-delta put has roughly a 30% chance of ending up in-the-money, regardless of market conditions. Percentage-based strikes, in contrast, might represent a 40% risk one month and a 20% risk the next.

Professional traders typically use delta terminology. They don’t say “5% out-of-the-money” – they say “30-delta.” This standardization makes it easier to compare different approaches.

Most importantly, delta provides clear position sizing guidance. A 30-delta put might be 5% out-of-the-money in calm markets but only 3% out in volatile ones, automatically adjusting risk levels to remain consistent.

Choosing the Right Expiration

The choice of expiration dates presents another critical consideration. The 30–45-day timeframe typically offers an optimal balance:

• Long enough to avoid aggressive time decay
• Short enough to maintain reasonable option prices
• Sufficient duration for typical market corrections
• Aligns with standard monthly option cycles

Several timeframes present specific challenges:

• Under 20 days: Positions decay too rapidly
• Over 60 days: Excessive capital requirements
• Weekly options: Complex management requirements

A systematic monthly approach often works best:

• Initiate positions around the 15th of each month
• Use the following month’s expiration
• Consider rolling positions with 15 days remaining

This creates a structured review and adjustment cycle without requiring constant monitoring.

Position Sizing: How Much to Protect

One of the hardest questions I’m wrestling with is: How much of my portfolio should I actually protect? My first instinct was “all of it,” but I quickly learned that’s not so simple.

I find myself thinking about my home insurance. I don’t insure every item in my house – just the important stuff. Maybe portfolio protection works the same way?

Let’s work through a typical scenario. Say I have $100,000 invested in the market. My first instinct might be to protect all of it, but here’s why that’s not the best approach:

First, let’s understand the basic building blocks. One SPY option contract controls 100 shares. With SPY at $400, that’s $40,000 worth of exposure. A single Back Ratio or Risk Twist unit typically works with one contract. Already, I can see that protecting my entire $100,000 would mean multiple units – adding complexity and cost.

The 30% Rule

Many suggest starting with around 30% coverage. On my $100,000 portfolio, that would mean protecting about $30,000 worth – which interestingly matches up with most of one option contract’s coverage. I’m still testing if this level makes sense.

Why 30%? Looking at market history, severe corrections rarely exceed 30% in a single month. The COVID crash of 2020 took several weeks to reach its lowest point. The 2008 financial crisis, while devastating, played out over months.

But here’s where Taleb’s wisdom becomes crucial: just because something hasn’t happened doesn’t mean it won’t. As he warns in “The Black Swan,” the most devastating market events are often the ones nobody saw coming, precisely because they hadn’t happened before. The turkey is well-fed and happy every day until Thanksgiving.

So, I’m faced with this puzzle: If worse crashes are possible, why consider 30% protection? I’m thinking about it like a deductible on insurance – accepting some risk to keep costs manageable. Maybe this level gives me a starting point, something I can adjust as I learn more about how these strategies work in different market conditions.

Scaling Up

Should I increase it during riskier periods? How much is too much? I notice that my cash and bond positions already provide some cushion – maybe that affects how much options protection I really need?

These are questions I’m still working through, and I suspect the answers might be different for each person’s situation.

Keeping It Simple: Managing Your Protection

Since I’m regularly adding to my broad market ETFs like VWRA every month, I needed to figure out how to sync my protection strategy with my investment routine. Here’s what I’m learning works best:

Around the middle of each month, I:

• Make my regular ETF purchase
• Look at how much my total portfolio has grown
• Check if I need to adjust my protection level

For example, if I started with $100,000 and 30% protection, but after three months of DCA and market growth I’m at $110,000, I might need to think about increasing my protection. But I don’t adjust for every small change – that would get expensive. Instead, I wait until my portfolio has grown enough to warrant another options contract.

I’ve found three main situations that make me consider changes:

First, when my portfolio grows significantly – either from my monthly investments adding up or from market gains. If I started protecting $30,000 of a $100,000 portfolio, and now I’m at $120,000, I might want to increase my protection to $36,000 to maintain that 30% coverage.

Second, if market conditions change dramatically. Sometimes volatility spikes, making my current strategy too expensive. Other times, it drops enough that I might be able to get more protection for the same cost.

Third, when my protection is about to expire. About a week before expiration, I look at:

• How much I’ve added to my portfolio since last month
• Whether market conditions suggest sticking with Back Ratio or switching to Risk Twist
• If I can roll my position to the next month at a reasonable cost

The key is keeping it systematic but not rigid. I don’t force changes just because the calendar says so, but I don’t ignore my protection until it’s too late either.

Conclusion: What I’ve Learned About Protection

When I started exploring Taleb’s ideas about protection, I never expected to end up deep in the weeds of options strategies. But that’s where the search for affordable protection led me. These Back Ratio and Risk Twist strategies aren’t perfect solutions – I’m still testing and learning – but they’re giving me practical tools to work with.

What fascinates me most is how they tackle the cost problem that made me hesitate about protection in the first place. Sure, I could just buy puts but watching 1-2% of my portfolio disappear every month was hard to stomach. These ratio spreads offer a different way – sometimes even paying me to put on protection when markets get scary.

I’m learning that success with these strategies isn’t about perfect timing or clever adjustments. Instead, it’s about being systematic: using deltas to pick strikes, maintaining a monthly routine alongside my regular ETF purchases, and letting the mathematics of options work in my favor.

But perhaps most importantly, I’m realizing these strategies are just one piece of my protection puzzle. Combined with my regular DCA into broad market ETFs, maintaining some cash reserves, and understanding my own risk tolerance, they’re helping me build a portfolio that lets me sleep at night without sacrificing too much upside.

Sources:

• Nassim Taleb’s Antifragile and The Black Swan
• Mark Spitznagel’s Safe Haven
• Moontower Blog and Moontower Meta

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Disclaimer: This essay documents my personal journey of learning about options and financial markets. It’s part of my ongoing self-education process and should not be considered financial advice. Options involve significant risks and aren’t suitable for all investors. Always conduct your own research and consult with qualified financial professionals before making any investment decisions.