So I rushed into a trade that I thought looked promising. Not much money so that's no big deal, but I have some questions and as long as you answer them helpfully you can insult the crap out of me as well : ) Got into a calendar spread SVNT last week. Sold Jun 5 @ 1.86. Bought Jul 5 @ 2.14 (.28 debit spread). The imp vol is high because of an FDA panel for their drug on the 16th. The high imp vol obviously meant my break even points were pretty wide (about 3 - 10) for a stock trading at 5.50 when I entered into the trade. My plan is to close the trade on the 15th taking advantage of theta decay and not risk exposure to the wild price swings that will certainly occur after the FDA meeting gives either good or bad news. So if you take a look at the spread today we are looking at .20 and falling, obviously a short term loss, while the stock sits comfortably within range at 5.72. It just seems like Jul isn't holding up its end of the bargain in the short term and I suppose that has a lot to do with the lack of liquidity in the Jul options. Am I simply not giving this enough time to play out? I know with theta accelerating as we approach expiration things will look a lot better on the 15th when I plan to close this out. Or are there things I'm not taking into account here (certainly) that are hurting me? Thanks for your help.
You are not taking into account the much steeper run up in volatility in the front month relative to the next month as you get closer to the announcement day. In fact, this is the most likely reason you don't see any time decay and you probably won't see it at all as the rising volatility more than compensates for the daily decay.
Thanks for your reply. Very soon after I posted this message I realized this is definitely what is happening, so I'm glad you can confirm that. How do you think I extricate myself from this situation?
Close out the position, if it doesn't reflect your current view/forecast for the stock. On the other hand, if you think that the stock is gonna stay flat once the announcement is out then you may wanna hold on to it.
You're ignoring the vol-line and simply looking at the switch-vol. You're NET LONG VOL and bought the high-print. You're short gamma and long vega, and I'll predict that vols will drop 2/3 across all durations when the news hits. My guess would be a <$.10 calendar after the news. Your b/e assumptions are based-upon a flat vol-line. What are the odds that vols stay bid?
I appreciate the help. This could have been a lot worse than it was. I got out this morning as vol went in my favor today to bring me back so that I only needed to take a small loss. I got out at .20 There doesn't seem to be any way to simulate changes in vol like that via the models and charts on thinkorswim. Or else I certainly would have accounted for this from the outset (not that I shouldn't have anyway). Another wannabe trader smacked down, and another lesson learned for me.
Sure you can simulate it in thinkorswim. On the Analyze tab add a simulated trade - calendar spread - then there's a little wrench just above the simulated trade in the "Delta" column, click on this wrench and additional paramteres open, then click on the blue arrow next to "More". This should open additional parameters where you can adjust the volatility for each month separately.
MTE, since you have been so helpful, can you explain something. Changing vol is certainly the thing I don't understand well enough and I won't be getting into another trade until I completely wrap my mind around it. For example today the near month vol increase wasn't even close to the amount of far month vol. (.13 v .23 as of this moment) http://quote.morningstar.com/Option/Options.aspx?sLevel=A&ticker=SVNT Whereas yesterday it was the opposite. What is the math behind that? What is that changing vol related to and why would it fluctuate in an inconsistent manner like that from day to day. Thanks for the TOS tip as well.