Question about Vega & Setting up a Short Calendar Spread

V

ValZ2020

Hello guys,

I am quite new to calendar spreads, so I apologize for a somewhat novice question. In understand that the core things to look at in setting up a short calendar spread is an "abnormal" difference in iVol between front and back month (in hope that the gap will "squeeze" back to normal) as well as overall iVol percentile being high and ideally higher than historical vol.

My question is about vega. Am I correct in understanding that if a back month put has a higher vega than the front month, it means that each 1% DROP in Ivol will reduce the back month's option price by more than the price of the front month option? In other words (all other things being equal) selling a calendar spread in high iVol and buying it back in low iVol should be a winning trade?

Many thanks!!!
 
Depends, buying a calendar spread is+vega, -theta(+$); in this case if the vega drop exceeds the theta gain the position will lose $. In general terms, if shorting the spread you need the vega drop to happen quickly to offset your theta losses otherwise it will lose
 
ValZ2020 said:
Hello guys,

I am quite new to calendar spreads, so I apologize for a somewhat novice question. In understand that the core things to look at in setting up a short calendar spread is an "abnormal" difference in iVol between front and back month (in hope that the gap will "squeeze" back to normal) as well as overall iVol percentile being high and ideally higher than historical vol.

My question is about vega. Am I correct in understanding that if a back month put has a higher vega than the front month, it means that each 1% DROP in Ivol will reduce the back month's option price by more than the price of the front month option? In other words (all other things being equal) selling a calendar spread in high iVol and buying it back in low iVol should be a winning trade?

Many thanks!!!
More...

You cannot generally aggregate Raw Vega across different months to determine the position's nett Vega ... better to weight the Vega's from different expiries using Square Root Time or similar
 
Guys many thanks for your responses! As I'm reading through Chen's and Sebastian's "The Option Trader's Hedge Fund" (pages 113-114) they also note that it's important to look at difference in iVol between back and front month in a short calendar. I set mine up for ADBE when the 15 delta put strikes, 1.5 months apart, were at ~5% difference in iVol (~45% and 50%) and the back month was not an "earnings" month. Current iVol for the underlying is in the 55% percentile. Would you say, based on your experience, is that this divergence (5% difference in iVol between back and front 1.5 months apart) is higher than normal and is more likely to "contract" or is there way more to this?
 
You must log in or register to reply here.
Back
Top