Atticus, The calendar it there not for gain although it will produce nice one at 1125, Its there to prevent a loss if mkt does not crash just drops a small amount or holds even, or even goes up 7%, and it only hurts the profit a small amount if it does crash. Does that make sense? BTW on that setup a IV drop will hurt and IV gain help, quite a bit. Thanks
I would not do this trade for the simple reason of term risk. If vols explode in AUG or SEP the front month is going to go absolutely bananas (which you'll be short) and the back month will probably remain a bit more tepid as it will be pricing in the next 6 months of mean revision vol which will be expected at that time, no matter what the market is doing. Consequently, its actually possible that you could LOSE money on this trade, depending on how your weighted vega is calculated. Chances are you won't lose, but your profits could be quite a disappointment. The only reason I would do this is the following. There are instances when I have decide that an underlying would go up or down to a particular price and then stay there. You can buy an OTM calendar with the front month in a near term and the back being way out or even a leap. If your market prediction is correct AND you plan to hold the position to the expiration of the front month, AND the market sits for a long time after the move, you may have a nice opportunity to sell many many expensive front month calendars spreads against a once very very cheap back month. I used to do this on both sides of GOOG because if you're correct you could possibly make 10:1 or better. You'll need to plan to roll around a bit to keep the back month in play, but all in all, a lot needs to happen in your favour in order for this to go off without a jumbled mess. No matter how you look at it, it's a crash or sell off spec play - not crash protection.
That's what makes a market. I like it due to the synthetic vol in the trade. I'll take the deltas over the switch-risk anytime. I'm not in it because my average hold is less than 10 days, and I don't like the delta position, but the vols look decent with a bit of time on your side. In a month is looks fantastic from 1000-1100. Under the OPs parameters I'd take the d/g/v position in the calendar at the current term structure over the switch-risk. I would bet it is good until at least 65% on the front month and 1500bp on the switch. The OP could also take a position in the VIX options, but I haven't looked at the variance market in a while.
It would be interesting to see what prices you would realize in a crash but my personal experience is that the synthetic vol (or the process of elongating or lessening time to expiration) may force you to remain in the position long after the major price move has completed and consequently you're open to unmitigated delta risk.
Yeah, I agree it's a balancing act. I would likely have to pull it early, rather than eat it on the flip.
Right, and that's the catch. The optimal moment for getting out (if you're trying to take advantage of any crash metric) is when vol is the most pumped and the market is nearly locked up. I wouldn't want to be short much of anything front month if the market crashing was my original plan. Anyhoo.. since I'm a net seller of premium, I guess I'm always short something near the front month and I do expect future crashes..... go figure!
.....this sounds interesting: ""The Garbage Trade We all fear âthe big drop.â You know what Iâm talking about Iâm certain. The big unexpected drop in say the stock market or the bond market or some individual stock or whatever, the one that seems to catch everyone by surprise."" http://finance.yahoo.com/news/Kaeppels-Corner-Seeking-opt-3637607540.html?x=0&.v=1
5-10% over 6 months is within the bounds of random noise, so if your conviction is that low then you might as well stay flat.
That's true, but thats where we normally buy units in order to protect from the very type of movement you're planning on profiting from. Valuable information, maybe - maybe not.... depends if you're the one selling the puts to me :^)