28 lines
1.9 KiB
Plaintext
28 lines
1.9 KiB
Plaintext
lower strike, the IV is naturally higher for the 70 calls. This is vertical skew
|
||
and is described in Chapter 3. The phenomenon of lower strikes in the same
|
||
option class and with the same expiration month having higher IV is very
|
||
common, although it is not always the case.
|
||
Backspreads usually involve trading vertical skew. In this spread, traders
|
||
are buying a 30 volatility and selling a 32 volatility. In trading the skew, the
|
||
traders are capturing two volatility points of what some traders would call
|
||
edge by buying the lower volatility and selling the higher.
|
||
Based on the greeks in Exhibit 16.2 , the goal of this trade appears fairly
|
||
straightforward: to profit from gamma scalping and rising IV. But, sadly,
|
||
what appears to be straightforward is not. Exhibit 16.3 shows the greeks of
|
||
this trade at various underlying stock prices.
|
||
EXHIBIT 16.3 70–75 backspread greeks at various stock prices.
|
||
Notice how the greeks change with the stock price. As the stock price
|
||
moves lower through the short strike, the 70 strike calls become the more
|
||
relevant options, outweighing the influence of the 75s. Gamma and vega
|
||
become negative, and theta becomes positive. If the stock price falls low
|
||
enough, this backspread becomes a very different position than it was with
|
||
the stock price at $71. Instead of profiting from higher implied and realized
|
||
volatility, the spread needs a lower level of both to profit.
|
||
This has important implications. First, gamma traders must approach the
|
||
backspread a little differently than they would most spreads. The
|
||
backspread traders must keep in mind the dynamic greeks of the position.
|
||
With a trade like a long straddle, in which there are no short options, traders
|
||
scalping gamma simply buy to cover short deltas as the stock falls and sell
|
||
to cover long deltas as the stock rises. The only risks are that the stock may
|
||
not move enough to cover theta or that the traders may cover deltas too
|
||
soon to maximize profits. |