A Good Ex-Skews
It’s important to take skew into consideration. Because the January calls
have a higher strike price than the February calls, it’s logical for them to
trade at a lower implied volatility. Is this enough to justify the possibility of
selling the lower volatility? Consider first that there is some margin for
error. The bid-ask spreads of each of the options has a volatility disparity. In
this case, both the January and February calls are 10 cents wide. That means
with a January vega of 0.34 the bid-ask is about 0.29 vol points wide. The
Februarys have a 0.57 vega. They are about 0.18 vol points wide. That
accounts for some of the disparity. Natural vertical skew accounts for the
rest of the difference, which is acceptable as long as the skew is not
abnormally pronounced.
As for other volatility considerations, this diagonal has the rather
unorthodox juxtaposition of positive vega and negative gamma seen with
other time spreads. The trader is looking for a move upward, but not a big
one. As the stock rises and Apple moves closer to the 420 strike, the
positive delta will shrink and the negative gamma will increase. In order to
continue to enjoy profits as the stock rises, John may have to buy shares of
Apple to keep his positive delta. The risk here is that if he buys stock and
Apple retraces, he may end up negative scalping stock. In other words, he
may sell it back at a lower price than he bought it. Using stock to adjust the
delta in a negative-gamma play can be risky business. Gamma scalping is
addressed further in Chapter 13.