With the short calendar earnings play, you are paying for a very very expensive gamma, so you need to short a contract in the back months that is very very rich in vols so that a flat open doesnt hurt you. Every now and then when the tenor skew is relatively flatter, you can establish a vega neutral position, which means you break even with a flat open. And no it is not an arb, you still have to call the magnitude of the vols collapse right. In this case, any move will yield gains due to your long gammas. That's what iv was talking about.
Reverse Calendars
- Thread starter IV_Trader
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I think I understand the question better. It's a question of ratios. If you sell the same number of long term straddles as you buy near term straddles, then that benefits primarily from a decline in volatility, but has price movement risk because the short straddles has more gamma than the long one.
IV's trade is to sell just enough longer term straddles to create a vega neutral position, so that the extra gamma on the long near term straddle is positioned to benefit from a large price move yet you are hedged against the vol collapse. The caveat is that the absolute change in implied vol will differ by month, so you would ideally model the change in vols independently of each other (like rally said).
IV's trade is to sell just enough longer term straddles to create a vega neutral position, so that the extra gamma on the long near term straddle is positioned to benefit from a large price move yet you are hedged against the vol collapse. The caveat is that the absolute change in implied vol will differ by month, so you would ideally model the change in vols independently of each other (like rally said).
I appreciate everyone's responses - thank you very much!
More questions though if you don't mind.
For the sample trade IV posted: it wasn't vega neutral, was it? I entered it in Platinum and it showed a vega of -0.16 (or -$16.03 as Platinum shows it). It looks pretty big for a vega.
Also I noticed a big skew between January options (110%) and February options (44%). How does that generally affect RC? Does it matter in this case because of only 2 days until expiration? BTW, what is tenor skew?
How do you choose between entering a combo like that and a single RC? And do you usually trade those very close to expiration?
A lot of questions, I know... Now I am going to go back and read all the responses again and again.
More questions though if you don't mind.
For the sample trade IV posted: it wasn't vega neutral, was it? I entered it in Platinum and it showed a vega of -0.16 (or -$16.03 as Platinum shows it). It looks pretty big for a vega.
Also I noticed a big skew between January options (110%) and February options (44%). How does that generally affect RC? Does it matter in this case because of only 2 days until expiration? BTW, what is tenor skew?
How do you choose between entering a combo like that and a single RC? And do you usually trade those very close to expiration?
A lot of questions, I know... Now I am going to go back and read all the responses again and again.
Doing a calendar/reverse calendar with straddles is redundant. No need to sell/buy BOTH puts and calls; one or the other will suffice.
IV
I understood the explanations of Ursa and Rally, but i still dont understand your expectations. meaning:
You open your position when you have at least 1500 bp difference in vols between front and back months - the assumption here is that the higher volatility in the back month is due to the uncertainty about earnings.
Than (after the position is in place) you hope for vols ramp in the front month against the back one. Right?
Why would that happen? The uncertainty is still in the back month!
I'm not trying to be a wise ass! furthermore my next question will prove i'm a newbie!!
How do you measure volatility in basis points? Example:
front month vol 49.37
back month vol 35.45
Is the diff 1392 bp?
Thanks in advance
I understood the explanations of Ursa and Rally, but i still dont understand your expectations. meaning:
You open your position when you have at least 1500 bp difference in vols between front and back months - the assumption here is that the higher volatility in the back month is due to the uncertainty about earnings.
Than (after the position is in place) you hope for vols ramp in the front month against the back one. Right?
Why would that happen? The uncertainty is still in the back month!
I'm not trying to be a wise ass! furthermore my next question will prove i'm a newbie!!
How do you measure volatility in basis points? Example:
front month vol 49.37
back month vol 35.45
Is the diff 1392 bp?
Thanks in advance
Not sure if that is the strategy. In any case, if the IV is bloated you expect it to deflate some time soon. The backmonth contracts have a far bigger vega (IV sensitivity) then the front months. So deflation of the IV bubble will benefit the short calendar (as does a big sideways move).
But maybe IV_trader is using another, more complicated aspect of RC's. They have a lot of hidden surprises. We'll see
Ursa..