Are you sure about this? The backspread will decay too you know. I am too lazy to model it myself but the position by definition is quite neutral everything. The two parts of the body are a nearly perfect offset to one another. As i said previously, i dont see this moving away from neutrality by much so i dont see the big profit potential except maybe for the MM who took the vig on 3 legs. lol
Just look at current NOV ES and DEC ES with OCT expiration just two weeks away. The ATM backspread has about 10 points of net credit. Assume that the market stays sideways from now until 2 weeks and the OCT 1360 would expire worthless. Are you telling me that the NOV and DEC would decay so much as to remove the 10 point net credit between them. Their thetas are mostly offsetting according to the Greeks. NOV 1360 has theta of -.2247 DEC 1360 has theta of -.1862. I would be left long 2 NOV and short 1 DEC for a net theta of -.2632. I doubt that all 10 points in the difference would decay away. Assume the net credit to close fades to 2. That is still a profit to close when you add the net credit I receive to open. MOREOVER, I could (using current prices which would have to be adjusted for 2 more weeks of decay) I could sell 2 1365 Calls at combination of 31.50 and BUY back the DEC 1360 Call for 26.00 for a huge net credit and be left with a nice bull call spread position in NOV. You keep mentioning that the position would simply offset each other. Since I open the position for a net credit, wouldn't that result in me closing out the spread at even and keeping the net credit. Right now the OCTEW/NOVES/DECES 1395 spread can be opened for a 3.00 credit. I am trying to find the holes and risk in this as well, but what you pointed out actually helps me (i.e. spread being worth $0). Moreover, current option prices and partially offsetting theta show that the backspread would still have a net credit to close for a profit. EDIT: The point for discussion is to locate the true risk so I can analyze the profit potential and also see what hedges are available.
I thought I mentioned before but perhaps only in mind mind, that opening a position for a net credit as you like to do, does not guarantee a credit at expiration. Hmm...now that I've put that down in print it seems even more ridiculously obvious than when it was in my head. I mean, it is obvious isn't it? Perhaps it's just me. You can open all kinds of spreads for net credits. You could just write a gazillion naked options for a net credit. None of the above necessarily makes for an expiration net credit though. Duh! Okay, now that I'm done conversing with myself, my questions would be: 1) Where is your risk hole at expiration? If we rally, the long calendar makes money. If we fall, the short calendar makes money, ignoring volatility. Therefore, the risk hole is somewhere in the middle. Probably round about where we are now i.e. if we finish at expiration where we are you will be looking at a loss - regardless of any net credit on the position. You do not have an expiration risk profile that is entirely above zero, otherwise I would keep it a secret. Actually, now I remember writing this before, not just in my head, but I can't be bothered to look it up. 2) What is the risk/reward on the position? i.e. what is the max loss and max reward at front month expiration. I'm guessing around 1:1 at best? Profit zone quite narrow near the target strike. We'll leave the modelling to you! Thanks. MoMoney.
>Therefore, the risk hole is somewhere in the middle. Probably round about where we are now While we are talking about the obvious, theta needs to be very low at the middle -- no below water sag at expiration.
Mo: The problem is I am testing actual numbers and if we are slightly OTM at expiration of the first wing, the position can still be closed for a net credit. I have to test it more on ToS in each leg. Of course just because I get a net credit does not mean I keep it. But if I get a net credit to close under certain circumstances then it increases the profit. If it takes a net debit to close but it is smaller than the net credit then I still have a profit. These are the scenarios I am coming up with and finding nice profit zones. You guys are raising great questions but you are asking theoretically. I am looking at the greeks and comparing current ITM and OTM spreads near OCT expiration and looking ahead at NOV/DEC expirations to see how the greeks end up. I will try and model the legs but if the market falls, the short wing expires worthless and the remaining backspread either has a net credit close (profit), small net debit (profit from my testing) or a larger net debit which leads to a SMALL limited loss. If the market rallies strong past the strike, the entire FLY can be closed out for pretty much even- again keeping the net creidt minus commissions. If the market is right near the short strike, the remaining backspread has net credit to close for a profit. So although I want to get on ToS and play around, looking at the current quotes and greeks leaves me with I find above on the profit side. My goal is to find the real, not theoretical risk, so I can judge it for the credit and profit potential. The true caveat is this has to be closed at first wing expiration to remove addition risk from backspread.
Even with 2 weeks to expiration the ATM cross month FLY can be closed for a net debit/credit of $0. So assuming I opened the OCT/NOV/DEC for a net credit I could close it now. I think taking action right after first wing expiration is what keeps the potential loss extremely limited. First thing I will test is the backspread at expiration going forward from here. Instread of 1360 ES strike I can use the 1350 SPX strike which is about the same in relation.
Phil, it doesn't matter if we are researching it theoretically vs your real numbers. I highly doubt there are any inefficiencies in the ES /EW options. Perhaps, it might help if you look at the position as a long and short calendar and not a short call and a callendar backspread.(??) They are both the same but it might give you a better perspective. I think its the easiest way to model it. I'd model the long and short calendars independently of one another and then merge the PnLs at each point of potential adjustment. Just like mo said, the profit zone is very very narrow and its position on the price axis would largely depend on how the greeks(delta and vegas) end up at expiration. Could be the short strike, could be away, could be far away. My guess is still that the position is vega dominated, hence it would depend on the vols. Risk/Reward at 1:1 2:1 at best. Still better than a FOTM vertical or call diagonal but you need a very accurate underlying prediction. If you can pull it off, more power to you.
Guys, I never proclaimed this a risk free trade, I just conveyed what I have found. That is why I was saying theoretical v. realistic. I am looking at actual number to determine where the risk lies. I know in theory no position is risk free but you guys are saying in a blanket statement that the profit zone is very narrow. My numbers are showing otherwise so I am throwing it out there to see what our collective heads can come up with.
Here is the ToS screen shot based on the following SPX position: Long NOV/OCT 1350 Calendar Short DEC/NOV 1350 Calendar result is OCT/2NOV/DEC 1350 cross month FLY. Screen shot is at OCT expiration... According to the sim, the downside breakeven is at 1315 and the upside is at 1390. IS THIS SHOWING THE COMBINED POSITIONS are just the front calendar? PICTURE DELETED... read below