I stole a comment by Michael from the OptionClub Yahoo Group.
It's one approach to Calendars. :eek:
--- In
OptionClub@yahoogroups.com, Michael Catolico <mcatolico@m...>
wrote:
>
> i look at calendars as a variation on a butterfly. they act much the
> same as flies in that the goal is to have the underlying expire as
close
> to the short strike as possible. however they are more complex since
by
> trading a calendar you are trading volatility.
>
> an ATM calendar is what i consider a schizophrenic trade. because you
> are short an ATM strike you want the underlying to basically do
nothing
> and sit still. but because you are long a back month strike you are
long
> vega. that means you want the stock to be volatile. if the stock dies
> your short premium comes in but so does your long premium. if the stock
> moves around, IV increases but the price movement can swing out of your
> ATM price zone. so you can therefore lose in two conflicting ways.
>
> that's why i prefer calendars in two circumstances 1) making cheap
> directional bets on near term events and 2) setting up a position
into a
> back month news event or earnings play.
>
> as a directional bet i look for situations where news is going to
happen
> in the front month. here usually there is a skew with front month IV
> higher than back month IV. when the news comes out there will be
certain
> IV crush across the board but hopefully the price movement will more
> than capture the vega loss. i analyze the play by assuming IV on the
> whole position will drop to slightly below the long term IV average and
> then look at my risk/ reward scenario.
>
> as an example look at CEPH which has earnings this week. the stock is
> trading around $45. i might take a bet that earnings will disappoint
and
> try a NOV/DEC 40 calendar. because earnings are happening soon NOV IV
> is skewed higher than DEC IV (49% vs. 40%). i can buy the calendar for
> about $0.30. long term IV averages about 35%. if i look at what the
> spread is worth if IV goes to say 30% i'd examine the value of the
> spread. if the stock is unchanged and IV drops to 30%, the spread will
> be worth about $0.20 by next week. if the stock drops to 40 the spread
> will be worth about $0.60. and of course if i'm wrong on direction and
> the stock gaps higher the trade is probably worthless. so given those
> three scenarios it's not too bad of a trade, especially if there is any
> reason to be especially bearish.
>
> for the second type of situation where i'll look at a calendar is when
> news is expected after front month expiration. since earnings season is
> basically winding down i don't have a good example for this. but
suppose
> a stock has earnings the week after NOV expiration. i might look
to do
> an ATM NOV/DEC calendar thinking that the stock might remain quiet
> through expiration. but with earnings coming shortly after, there's a
> good chance that the DEC IV will remain strong and perhaps increase. so
> by doing the spread now i put myself in a decent position to own that
> DEC option cheaply and then using that as an anchor leg for a spread
> going into actual earnings.
>
> in general i always try to match the expirations as closely as possible
> (e.g. i don't buy a LEAP and sell front month premium against it) since
> the correlation in IV gets weaker the farther apart the expirations
are.
> and generally i like to get calendars where i think i can at least
> double the value if held until the short expiration.
>
> michael
