24 lines
1.6 KiB
Plaintext
24 lines
1.6 KiB
Plaintext
Selling the Front, Buying the Back
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If for a particular stock, the February ATM calls are trading at 50 volatility
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and the May ATM calls are trading at 35 volatility, a vol-calendar trader
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would buy the Mays and sell the Februarys. Sounds simple, right? The devil
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is in the details. We’ll look at an example and then discuss some common
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pitfalls with vol-trading calendars.
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George has been studying the implied volatility of a $164.15 stock.
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George notices that front-month volatility has been higher than that of the
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other months for a couple of weeks. There is nothing in the news to indicate
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immediate risk of extraordinary movement occurring in this example.
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George sees that he can sell the 22-day July 165 calls at a 45 percent IV
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and buy the 85-day September 165 calls at a 38 percent IV. George would
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like to buy the calendar spread, because he believes the July ATM volatility
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will drop down to around 38, where the September is trading. If he puts on
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this trade, he will establish the following position:
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What are George’s risks? Because he would be selling the short-term
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ATM option, negative gamma could be a problem. The greeks for this trade,
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shown in Exhibit 11.7 , confirm this. The negative gamma means each
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dollar of stock price movement causes an adverse change of about 0.09 to
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delta. The spread’s delta becomes shorter when the stock rises and longer
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when the stock falls. Because the position’s delta is long 0.369 from the
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start, some price appreciation may be welcomed in the short term. The stock
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advance will yield profits but at a diminishing rate, as negative gamma
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reduces the delta. |