28 lines
1.9 KiB
Plaintext
28 lines
1.9 KiB
Plaintext
Chapter 39: Volatility Trading Techniques
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FIGURE 39-6.
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Volatility backspread neutral position.
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Underlying Price
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835
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in advance of the near-term expiration. It should not be allowed to deteriorate to the
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point of maximum loss.
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Modifications to the strategy can be considered. One is to sell even longer-term
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options and of course hedge them with the purchase of the near-term options. The
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longer-term the option is, the bigger its vega will be, so a decrease in implied volatil
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ity will cause the heftier-priced long-term option to decline more in price. This mod
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ification is somewhat tempered, though, by the fact that when options get really
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expensive, there is often a tendency for the near-term options to be skewed. That is,
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the near-term options will be trading with a much higher implied volatility than will
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the longer-term options. This is especially true for LEAPS options. For that reason,
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one should make sure that he is not entering into a situation in which the shorter
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term options could lose volatility while the longer-term ones more or less retain the
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same implied volatility, as LEAPS options often do. This concept of differing volatil
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ity between near- and long-term options was discussed in more detail in Chapter 36
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on the basics of volatility trading. As a sort of general rule, if one finds that the longer
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term option has a much lower implied volatility than the one you were going to buy,
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this strategy is not recommended. As a corollary, then, it is unlikely that this strate
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gy will work well with LEAPS options.
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One other thing that you should analyze when looking for this type of trade is
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whether it might be better to use the puts than the calls. For one thing, you can estab
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lish a position in which the heavy profitability is on the downside (as opposed to the
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upside, as in the XYZ example above). Then, of course, having considered that, it
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might actually behoove one to establish both the call spread and the put spread. If |