38 lines
2.9 KiB
Plaintext
38 lines
2.9 KiB
Plaintext
Chapter 37: How Volatility Affects Popular Strategies 781
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call bull spreads and some naked call options. For example, a call ratio spread might
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consist of buying an XYZ July 100 call and selling two XYZ July 120 calls. If one were
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to break it down into its components, this spread is really long one XYZ July 100-120
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call bull spread, plus an additional naked July 120 call.
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We already know that an increase in implied volatility is very detrimental to a
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naked call option. In addition, it was shown earlier than an increase in implied volatil
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ity actually harms the value of an at-the-money call bull spread. So, for a ratio call
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spread, both components are harmed by an increase in implied volatility. Conversely,
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a decrease in implied volatility would be beneficial to a ratio spread, but where naked
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options are concerned, one should be more mindful of his risk than of this reward.
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It was also shown previously that a call bull spread does not widen out much if
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the underlying stock makes a quick upward move. The spread won't widen out to its
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maximum profit potential until expiration draws nigh or the stock is well above the
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upper strike in the spread. This scenario also does not bode well for the ratio call
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spread. Suppose that the underlying stock suddenly jumps upward and implied
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volatility increases at the same time. That combination is seen quite frequently, espe
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cially if the stock were previously "dull" or if there is some sort of active corporate
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(takeover) rumor. The call ratio spread will fare miserably under these conditions,
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because the increase in stock price certainly harms the naked call position and the
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bull spread is not widening out much to compensate for it. In addition, the increase
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in implied volatility is working against both components.
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The same sort of thing happens with put ratio spreads. They are really the com
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bination of a put bear spread plus some additional naked put options. If the under
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lying falls in price, while implied volatility increases - a very common occurrence in
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all markets then the put ratio spread will fare poorly. In fact, implied volatility
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sometimes explodes if the underlying falls very rapidly (crashes), so the ratio put
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spreader should clearly assess his risk in this light.
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In summary, a trader utilizing ratio spread strategies should clearly understand
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and attempt to analyze the risks of an increase in implied volatility. This includes not
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only assessing the vega risk of the spread, but also using a probability calculator with
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some inflated volatility estimates to see just what the chances are of the spread get
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ting into real trouble.
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BACKSPREADS
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A call backspread is merely the opposite of a call ratio spread. Thus, any of the earli
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er commentary about how an increase in implied volatility is detrimental to a ratio
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spread can be reversed when discussing the backspread. An increase in implied
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volatility will be beneficial to a backspread strategy, while a decrease in implied |