24 lines
1.6 KiB
Plaintext
24 lines
1.6 KiB
Plaintext
Because volatility has peaks and troughs, this can be a smart time to sell a
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calendar. The focus here is in seeing the “cheap” front month rise back up
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to normal levels, not so much in seeing the “expensive” back month fall.
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This trade is certainly not without risk. If the market doesn’t move, the
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negative theta of the short calendar leads to a slow, painful death for
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calendar sellers.
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Another scenario in which the back-month volatility can trade higher than
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the front is when the market expects higher movement after the expiration
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of the short-term option but before the expiration of the long-term option.
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Situations such as the expectation of the resolution of a lawsuit, a product
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announcement, or some other one-time event down the road are
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opportunities for the market to expect such movement. This strategy
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focuses on the back-month vol coming back down to normal levels, not on
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the front-month vol rising. This can be a more speculative situation for a
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volatility trade, and more can go wrong.
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The biggest volatility risk in selling a time spread is that what goes up can
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continue to go up. The volatility disparity here is created by hedgers and
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speculators favoring long-term options, hence pushing up the volatility, in
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anticipation of a big future stock move. As the likely date of the anticipated
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event draws near, more buyers can be attracted to the market, driving up IV
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even further. Realized volatility can remain low as investors and traders lie
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in wait. This scenario is doubly dangerous when volatility rises and the
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stock doesn’t move. A trader can lose on negative theta and lose on negative
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vega. |