EXHIBIT 11.7 10-lot July–September 165 call calendar.
But just looking at the net position greeks doesn’t tell the whole story. It
is important to appreciate the fact that long calendar spreads such as this
have long vegas. In this case, the vega is +1.522. But what does this number
really mean? This vega figure means that if IV rises or falls in both the July
and the September calls by the same amount, the spread makes or loses
$152 per vol point.
George’s plan, however, is to see the July’s volatility decline to converge
with the September’s. He hopes the volatilities of the two months will move
independently of each other. To better gauge his risk, he needs to look at the
vega of each option. With the stock at $164.15 the vegas are as follows:
If George is right and July volatility declines 8 points, from 46 to 38, he
will make $1,283 ($1.604 × 100 × 8).
There are a couple of things that can go awry. First, instead of the
volatilities converging, they can diverge further. Implied volatility is a slave
to the whims of the market. If the July IV continues to rise while the
September IV stays the same, George loses $160 per vol point.
The second thing that can go wrong is the September IV declining along
with the July IV. This can lead George into trouble, too. It depends the
extent to which the September volatility declines. In this example, the vega
of the September leg is about twice that of the July leg. That means that if
the July volatility loses eight points while the September volatility declines
four points, profits from the July calls will be negated by losses from the
September calls. If the September volatility falls even more, the trade is a
loser.