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This column was originally published on RealMoney on Jan. 16 at 1:51 p.m. ET. It's being republished as a bonus for readers. For more information about subscribing to RealMoney, please click here.

The major indices are hugging the unchanged line at midday. Could this be a precursor to rampant

pinning action for this week's option expiration? I don't play that game, so I won't even venture a guess on pin candidates until midday Friday.

Despite the tight range, the VIX is up some 6% to 10.80. However, some of this lift is simply due to the "Monday effect" (though, in this case, Tuesday) in which the theta markdown that occurs on Friday afternoon basically prices in today's decay, providing an underpinning for options during the morning hours. Also, with earnings and expiration on tap this week, traders were more likely to come in this morning as net buyers of option premium, as positions get closed or rolled ahead of the expiration.

The impact of expiration-related activity should also be taken into consideration when looking at the put/call ratios. The all-exchange ratio popped above 1.10 this morning, the highest reading in six weeks, but the equity-only ratio is still a subdued 0.62, in line with the 20-day moving average. The put/call on index products has jumped to 2.80, its highest level in two months, and that is lifting the overall reading. Much of the volume is coming in the form of rolling of out-of-the money puts from January into February and, as such, does not represent large directional or bearish bets.

The notable exception is coming on the

Diamonds Trust

(DIA) - Get SPDR Dow Jones Industrial Average ETF Trust Report

, which has seen heavy put activity in the March series. The $125 strike has traded 34,000 contracts against prior open interest of just 3,000, and the $120 strike has traded 20,000 contracts against prior open interest of 10,000 contracts. There is no corresponding volume in January or February expirations. However, the trade could represent a ratio spread in which someone is buying the $125 puts and selling the $120 puts for a net debit of $1.30 for the 2x3 spread.

I bring this up because some recent articles in

The Wall Street Journal

have been citing options strategists who recommend ratio spreads as a way of establishing downside protection at a minimal cost. In addition, some services such as

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are reporting an increase in frequency in this type of trade.

This is not a strategy I would suggest implementing if I was worried about a selloff. The risk/reward is not attractive, and the position's price behavior will be exactly the inverse if the sharp selloff occurs.

With the Diamonds trading right around $125, a 2x3 spread would provide about 5% of downside protection, covering a move from $123.80 to around $118, yielding maximum a profit of $3.70 if shares are at $120 on the March 16 expiration.

But the position would start losing money if shares fell below $111.50, or slid 10.5%. Of greater concern is that the position would also be hurt by an increase in implied volatility, which would likely accompany a decline of 5% or greater. Lastly, even if the underlying price is at the max profit point, it is very difficult to pull off a ratio spread for a profit until you get to about two weeks before expiration. This means for the ratio spread to pay off, it needs to be just right in terms of the magnitude, velocity and timing of the price move. Basically, it's a bet that the Diamonds will calmly drift 5% lower over the next three months. That doesn't strike me as a high-probability scenario.

With options prices sitting near 13-year lows, I don't see the sense in using a ratio -- which gives only a narrow price range of protection, is exposed to unlimited losses and handcuffs the position to a three-month holding period -- just to reduce the initial cost. I believe you'd be better off just making an outright purchase of the March $123 puts at $1.20 per contract. This has the same initial cost, but provides unlimited downside protection and, more importantly, the flexibility to trade around a near-term selloff and increase in implied volatility.

Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback;

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