38 lines
2.7 KiB
Plaintext
38 lines
2.7 KiB
Plaintext
Chapter 13: Reverse Spreads 231
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calendar spread makes the most money if the stock is right at the strike price at expi
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ration, and it loses money if the stock rises or falls too far.
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As with any spread involving options expiring in differing months, it is common
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practice to look at the profitability of the position at or before the near-term expira
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tion. An example will show how this strategy can profit.
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Example: Suppose the current month is April and that XYZ is trading at 80.
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Furthermore, suppose that XYZ's options are quite expensive, and one believes the
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underlying stock will be volatile. A reverse calendar spread would be a way to profit
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from these assumptions. The following prices exist:
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XYZ December 80 call: 12
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XYZ July 80 call: 7
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A reverse calendar spread is established by selling the December 80 call for 12
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points, and buying the July 80 call for 7, a net credit of 5 points for the spread.
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If, later, XYZ falls dramatically, both call options will be nearly worthless and the
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spread could be bought back for a price well below 5. For example, if XYZ were to
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fall to 50 in a month or so, the July 80 call would be nearly worthless and the
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December 80 call could be bought back for about a point. Thus, the spread would
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have shrunk from its initial price of 5 to a price of about 1, a profit of 4 points.
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The other way to make money would be for implied volatility to decrease.
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Suppose implied volatility dropped after a month had passed. Then the spread might
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be worth something like 4 points - an unrealized profit of about 1 point, since it was
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sold for a price of 5 initially.
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The profit graph in Figure 13-1 shows the profitability of the reverse calendar.
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There are two lines on the graph, both of which depict the results at the expiration
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of the near-term option (the July 80 call in the above example). The lower line shows
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where profits and losses would occur if implied volatility remained unchanged. You
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can see that the position could profit if XYZ were to rise above 98 or fall below 70.
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In addition, the higher curve on the graph shows where profits would lie if implied
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volatility fell prior to expiration of the near-term options. In that case, additional prof
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its would accrue, as depicted on the graph.
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So there are two ways to make money with this strategy, and it is therefore best
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to establish it when implied volatility is high and the underlying has a tendency to be
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volatile.
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The problem with this spread, for stock and index option traders, is that the call
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that is sold is considered to be naked. This is preposterous, of course, since the short
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term call is a perfectly valid hedge until it expires. Yet the margin requirements
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remain onerous. When they were overhauled recently, this glaring inefficiency was |