46 lines
2.8 KiB
Plaintext
46 lines
2.8 KiB
Plaintext
834 Part VI: Measuring and Trading Volatility
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described in the chapter on reverse spreads. The reader might want to review that
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chapter, not only for the description of the strategy, but also for the description of the
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margin problems inherent in reverse spreads on stocks and indices.
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One of the problems that most traders have with the reverse calendar spread is
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that it doesn't produce very large profits. The spread can theoretically shrink to zero
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after it is sold, but in reality it will not do so, for the longer-term option will retain
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some amount of time value premium even if it is very deeply in- or out-of-the-money.
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Hence the spread ·will never really shrink to zero.
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Yet, there is another approach that can often provide larger profit potential and
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still retain the potential to make money if implied volatility decreases. In some sense
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it is a modification of the reverse calendar spread strategy that can create a poten
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tially even more desirable position. The strategy, known as a volatility backspread,
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involves selling a long-term at-the-money option (just as in the reverse calendar
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spread) and then buying a greater number of near-er term out-of-the-money options.
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The position is generally constructed to be delta-neutral and it has a negative vega,
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meaning that it will profit if implied volatility decreases.
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Example: XYZ is trading at 115 in early June. Its options are very expensive. A trad
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er would like to construct a volatility backspread using the following two options:
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Call Option
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July 130 call:
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October 120 call:
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Price
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2.50
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13
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Delta
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0.26
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0.53
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Vega
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0.10
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0.27
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A delta-neutral position would be to buy 2 of the July 130 calls and sell one of
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the October 120 calls. This would bring in a credit of 8 points. Also, it would have a
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small negative position vega, since tvvo times the vega of the July calls minus one
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times the vega of the October call is -0.07. That is, for each one percentage point
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drop in implied volatility of XYZ options in general, this position would make $7 -
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not a large amount, but it is a small position.
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The profitability of the position is shown in Figure 39-6. This strategy has lim
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ited risk because it does not involve naked options. In fact, if XYZ were to rally by a
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good distance, one could make large profits because of the extra long call.
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Meanwhile, on the downside, if XYZ falls heavily, all the options would lose most of
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their value and one would have a profit approaching the amount of the initial credit
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received. Furthermore, a decrease in implied volatility produces a small profit as
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well, although time decay may not be in the trader's favor, depending on exactly
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which short-term options were bought. The biggest risk is that XYZ is exactly at 130
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at July expiration, so any strategist employing this strategy should plan to close it out |