As I am not too happy with the results, I have not deployed any Iron Condor lately. Nor I have had the chance of deploying a Put Spread, which is a trade that I am much happier with.
In the meantime I have been reading about Calendar Spreads and done a bit of paper trading with them. Today I would like to share my thoughts on them.
Note: This is not meant to be a proper study on Calendar Spreads, just some notes I have compiled on the way. Any serious study on a trading strategy requires a proper set of back tests.
Example Trade Setup: Positions opened, days until expiration (DTE) and debit invested
The calendar spread is composed of two positions (in this example PUT options for the German DAX30 - ODAX):
As the option in the future has more time value, this results in an overall debit.- Same strike price: 12500 points in this case.
- Different lifespan: A shorter one, using the front month (32 days) and longer in the other, some three or four months in the future (158 days).
- Short/long: You sell the front option and buy the option in the future.
For instance, this is the current status of a "paper trade" that I have simulated for a couple of weeks:
Results in this profit/loss graph:
The orange line is the profit/loss at the expiration date of the short option, while the blue line is displaying the profit/loss 9 days after opening the trade. Note that the amounts are all multiplied by 5 here as each ODAX option represents 5 contracts (or 5€ per point).
Now let´s take a look at the most important trade parameters, represented by the Greek letters Delta, Theta and Vega (the "Greeks") and shown in the table above:
Delta
Delta can be taken as the probability of the option to be "in the money". As the long option has much more time to realize that movement "into the money", it has a higher Delta than the short option.
This also means that it loses/gains value quicker than the short position with movements of the underlying asset.
Theta
Theta is the amount of money lost every day due to decay, as the closer the expiration day is, the lower is the probability of ending "in the money". When "shorting" an option Theta is good for you (you will have to pay less to re-buy the option) while it hurts you when "going long" (what you bought has less value each day it passes).
If we combine the Theta value of both options, the absolute value is bigger in the short position than in the long position, as the short position barely has four weeks of life. This means that the trade in a whole with these parameters, gains money with the passing of time.
In the graph above, the effect of Theta can be seen with the blue line approaching the orange one as the time passes.
Vega
Vega is the sensibility of the options´ price to the changes in the Volatility. The higher Vega is, the more the price is affected.
The long position has a higher Vega value than the short one, which means that its value will increase faster with an increment of the volatility.
In order to represent Vega´s impact on the trade, let´s represent the profit/loss graph again but rising the implied volatility from 15% to 17%:
 |
| Trade PL graph with Volatility at 15% Max profit is around 600€, loss at 12700 is around 75€ |
 |
| Trade PL graph with Volatility at 17% Max profit is 1000€, profit at 12700 is around 130€ |
Trade outcome with a sideways market
In a sideways market, where the underlying stays close but above the strike price of your options, you will be able to:
- Benefit from the positive Theta decay as time passes.
- The short position can be rolled month after month, reducing the overall debit, even to the point of having a net profit.
Trade outcome with a bearish market
If a drop in the underlying happens and both options fall into the money then:
- The Volatility will increase and you will benefit from positive Vega.
- At some point in the money, the Delta of both positions will be equal so losses from the short position will be compensated by gains from the long position.
- A limited profit will be made if the position is closed.
Trade outcome with a bullish market
When the underlying climbs, the trade will start losing money:
- Volatility will drop, so the trade will lose money due to negative Vega.
- The long position will lose more money than the money gained from the short position.
- Further rolls of the short position will be less profitable as they will be out of the money.
- Finally, the maximum loss you might incur into, will the be initial debit paid minus the credit obtained by rolling the short positions.
As you can see, when we open this trade is because we have a bearish/neutral view towards the market. What happens if you want to execute this trade with Call options no make it bullish?
Well, the problem is that when the market rises, volatility drops greatly and that affects to the remaining value of our long position (remember, it has a higher Vega value). Moreover, further rolls in this low volatility environment will provide less credit.
Conclusions
As described before, you can make money or, at least, compensate the debit invested in 2 out of 3 scenarios. If you happen to be in the wrong scenario what is fundamental is to reduce the amount initially invested, so this trade should be initiated when the market is showing a low volatility level and the options are "cheap" to buy, ideally at the end of a bullish period.
Resources
No comments:
Post a Comment