35 lines
2.5 KiB
Plaintext
35 lines
2.5 KiB
Plaintext
those profits are leveled off by the fact that theta gets smaller as the stock
|
||
moves higher above $80—more profit on direction, less on time.
|
||
For the delta player, bull call spreads and bull put spreads have a potential
|
||
added benefit that stems from the fact that IV tends to decrease as stocks
|
||
rise and increase when stocks fall. This offers additional opportunity to the
|
||
bull spread player. With the bull call spread or the bull put spread, the trader
|
||
gains on positive delta with a rally. Once the underlying comes close to the
|
||
short option’s strike, vega is negative. If IV declines, as might be
|
||
anticipated, there is a further benefit of vega profits on top of delta profits.
|
||
If the underlying declines, the trader loses on delta. But the pain can
|
||
potentially be slightly lessened by vega profits. Vega will get positive as the
|
||
underlying approaches the long strike, which will benefit from the firming
|
||
of IV that often occurs when the stock drops. But this dual benefit is paid
|
||
for in the volatility skew. In most stocks or indexes, the lower strikes—the
|
||
ones being bought in a bull spread—have higher IVs than the higher strikes,
|
||
which are being sold.
|
||
Then there are special market situations in which vertical spreads that
|
||
benefit from volatility changes can be traded. Traders can trade vertical
|
||
spreads to strategically position themselves for an expected volatility
|
||
change. One example of such a situation is when a stock is rumored to be a
|
||
takeover target. A natural instinct is to consider buying calls as an
|
||
inexpensive speculation on a jump in price if the takeover is announced.
|
||
Unfortunately, the IV of the call is often already bid up by others with the
|
||
same idea who were quicker on the draw. Buying a call spread consisting of
|
||
a long ITM call and a short OTM call can eliminate immediate vega risk
|
||
and still provide wanted directional exposure.
|
||
Certainly, with this type of trade, the trader risks being wrong in terms of
|
||
direction, time, and volatility. If and when a takeover bid is announced, it
|
||
will likely be for a specific price. In this event, the stock price is unlikely to
|
||
rise above the announced takeover price until either the deal is
|
||
consummated or a second suitor steps in and offers a higher price to buy the
|
||
company. If the takeover is a “cash deal,” meaning the acquiring company
|
||
is tendering cash to buy the shares, the stock will usually sit in a very tight
|
||
range below the takeover price for a long time. In this event, implied
|
||
volatility will often drop to very low levels. Being short an ATM call when |