Calendar backspread

[the learner]

Hi all,

I was looking at the calendar backspread strategy. If done with calls, it could be:

- short 1 call strike A maturing in Oct
- long 2 calls strike B maturing in Nov

with A<B. The position is long vega and profits if at Oct expiration the underlying is below A or well above B.

Now suppose that volatility goes down and that at Oct expiration the underlying is between strike A and B (thus the short Oct call expires ITM and remaining Nov calls drop in value because of volatility going down).

What adjustment would you perform?

One idea would be to sell, once previous Oct short call has expired, a new Nov call strike A (still with A<B) and transform the strategy into a (vertical) backspread. Or, also, selling 2 Nov calls strike A to transform in bear call spread.

Rational for each adjustment:

Backspread -> I expect increasing implied vol and high realized vol from Oct expiration to Nov's.
Bear spread -> I expect sideways/down move with stable or decreasing IV.

Any better idea?

Thanks for your help.

 

[crazyoptiontrader]

For this strategy, time decay is your friend. Because time decay accelerates close to expiration, the front-month call will lose value faster than the back-month call.
As you expect increasing vol, the backspread strategy is fine I guess U're better off if implied volatility increases close to front-month expiration. That will cause the back-month call price to increase, while having little effect on the price of the front-month option. (Near expiration, there is hardly any time value for implied volatility to mess with.)

 

[the learner]

Hi, thanks for you message. Any idea how to adjust this position in an adverse scenario like the one I presented above?

Thanks.

 

[Windlesham1]

it's not a back spread it's a ratio spread- very risky,and adjustment-you can convert your longs into spreads and use the premium to adjust the Oct short call if it goes ITM. Good luck-I've been hammered by calendars

 

[convexx]

it's not a back spread it's a ratio spread- very risky,and adjustment-you can convert your longs into spreads and use the premium to adjust the Oct short call if it goes ITM. Good luck-I've been hammered by calendars

No, it's a long diagonal (time) backspread. So sure, you have calendar risks as well. The long strike is the terminal distribution risk with a vertical backspread. The diagonal can do well if there is decent edge on the term structure. I would avoid unless Bvol/Avol >1. It can work well into earnings as vol usually ramps into the final week before earnings, but in this case it's B/A <1(demand for vol as synthetic time). Trade B/A > 1 if not targeting earnings.

 

[jimmyjazz]

How is this trade "very risky"? At front month expiry, aren't you just risking the net debit to place the trade?

 

[Windlesham1]

Vega is twice as weird as you think,and can increase your loss big time

 

[newwurldmn]

I don't understand the vega comment.

But to the OP the "adjustment" depends on your view. Will vol in nov continue to come in? Will the stock continue to rally? All relative to where its pricing.

What's your view in the scenario presented above?

 

[convexx]

For this strategy, time decay is your friend. Because time decay accelerates close to expiration, the front-month call will lose value faster than the back-month call.
As you expect increasing vol, the backspread strategy is fine I guess U're better off if implied volatility increases close to front-month expiration. That will cause the back-month call price to increase, while having little effect on the price of the front-month option. (Near expiration, there is hardly any time value for implied volatility to mess with.)

You really need to stop typing.

A long backspread is not a long theta proposition.

 

[Windlesham1]

I don't understand the vega comment.

But to the OP the "adjustment" depends on your view. Will vol in nov continue to come in? Will the stock continue to rally? All relative to where its pricing.

What's your view in the scenario presented above?

Vega is morew fickle than you think,thjat's all and you need to know that the front month can get weird,and PIN risk is also an unknown,and if it's exercised early you can really get cleaned up-seen it happen a few times-just saying if life was as simple as relative thesta we'd all be betting the farm