DCX Calendar spread - IV Crush

Discussion in 'Options' started by Jackdaw, Apr 13, 2004.

  1. Jackdaw


    A week or so back (2nd April) I sold a calendar put spread for DCX. Sold the April 45 puts for average 3.69 with stock at 43 and IV of 94%. Then bought the Jul 45 puts for average 4.63 with IV of 42%. The months were traded in the ratio of 7 short Aprils to 10 long July's.

    The p/l curve was very attractive, with a profit at all levels below 50, and I reasoned that if the stock price fell the IV would increase making the curve even more attractive.

    Price has fallen to 40.63 but IV for the July has dropped from 42 to 28, and the position is underwater - only by a small amount I admit, but never-the-less it is really frustrating to see the price move in what should be an advantageous way and for the position to be severely damaged by the IV crush.

    How would you guys have played it?

    How can I spot the potential for an IV crush? IV of 42% was not high for DCX.

    How would you play it now? I'm tempted to buy back the April 45's which are ITM (price 4.3/4.5) with stock at 40.55/40.64 (so time value negligible). Then just play the long puts, maybe turning it into a spread by selling the July 40's for 2.1.

    Another thought is having bought back the Aprils, sell (say) 20 July 40 puts, and buy 10 July 35's to turn it into a butterfly, and then deltahedge with stock.

    Any ideas gratefully received.
  2. Jack are u sure of the IV in the front month being in the 90's? i looked at ivolatility.com and it doesnt show 90 .Maybe the IV edge was not as big as u thought. Anyway, the vol range is from low 20's to 39 IV so you would be long vega around the 40th percentile. Not too bad but not earth shattering either.
  3. Jackdaw


    GATrader - I took the IV from the model calculated by Optionetics. I confirmed it by putting the figs into Hoadley and they checked out.
  4. Maverick74


    Did you put this on ahead of an earnings report?
  5. Yea, I'd have to agree with GA. A long time spread with the back month IV in the middle of it's range, regardless of the size of the skew, is a bad play. I'd be much more inclined to go with a vega neg position on the front month.
  6. Jackdaw


    Mav - yes, there was an earnings report on 7th April. Nothing earth shattering, although I had neglected to take into account it going ex-div (€1.50) on 8 April. But I expected a good earnings report to push the price up towards the short strike at $45, and a bad one to hit the price and increase the IV.

    Hello-dollars - Whilst understanding the principals, I sometimes have difficulty with the terminology! So apologies for what is going to appear a dumb question. My understanding of vega-negative on the front month, in this case, would be where I expected the IV for April to reduce - and that's exactly what I expected. What I didn't anticipate was the big reduction in IV for July. Could you give an example of what you mean by your statement please?

  7. Maverick74


    Jack, you never want to be long calendars going into an earnings report. The vol is always going to get crushed on the back months, always. If you want to play an earnings report you are going to need to modify your calendar. Such as leaning long or shot and putting on a ratio calendar so that you are short twice as many options on the front as you are the back. Plus the vol was way too high on the back months, you never should have bought vol up that high.
  8. Jackdaw


    Thanks Mav. So presumably this is what Hello-Dollars meant by being vega negative on the front month?
  9. Jack, that's one way to do it. Or you could just trade the front month with a short straddle/strangle or vertical ratio spread. Or, if you don't want to sit with the unlimited risk, a long butterfly/condor would also do the trick. Which one really depends on the specific situation and your particular risk tolerance.

    Bottom-line, there are lots of ways to do it. The main point here is to be careful not to be seduced into a long calendar spread that looks great on a risk graph because of a big horizontal skew, but doesn't take into account a decline in implieds on the back month from midling levels. It's a common cause of frustration among those who've traded the positions and why the strategy is usually not as attractive as it seems.
  10. Jackdaw


    Thanks guys - that's been really helpful - hopefully for others as well.
    #10     Apr 13, 2004