At the bottom is an update to the trade…
Below is my ‘guest post’ that was previously posted on Mark Sebastians’s blog www.option911.com.
I was reading Stock Twits and a tweet got my attention about Visa… Then I looked at the chart in Thinkorswim: (click any picture to enlarge)
Then I checked out the Live Vol (www.livevol.com) skew tab. Note the major vertical and horizontal skew:
The trade: Buy 10 Sep $80 puts (40.65% IV), sell 10 Jun $65 puts (57.75% IV) for a net debit of $9.16 per spread. V was trading at $74.20.
- Selling higher IV than buying.
- Sep expiry includes the 7/2010 earnings cycle. This should help maintain the IV of the Sep puts or even inflate IV of my long Sep puts prior to the event.
- I can also roll my short puts from Jun to Jul and then to Aug.
- Also, in theory if the underlying moves up, the Jun should lose IV faster than the Sep as the longs sell their inflated put protection.
- Tentatively, I’ll keep the $80 level in mind to stop out and accept that I was wrong. At current IV that equates to around a $4,500 loss, however, this could be more or less depending on changes in the skew.
As for profit taking:
- I will scale out depending on the price action. If the underlying doesn’t move much and the skew lessens I’ll take small profits.
- If the underlying moves down, I’ll take off one contract at a time but will not feel any rush to do this with positive theta on my side.
UPDATE as of 06/07/2010:
As you can see in the below chart V has been in a tight trading range since my entry on 5/21/2010. You can also see the both the Jun and Sep IV have dropped around 5% each.
With the underlying not moving much and the IV dropping for both months about the same there’s basically two variables that affect our trade. Vega and Theta. The Sep options that we’re long have a greater Vega than the Jun so the equal drop in IV causes this position to lose money, however, the Theta is greater for Jun and Sep causing this position to profit.
I’ve closed 3 spreads for small profits as the underlying moved down as below:
5/25/10 credit $9.76
5/25/10 credit $10.16
6/2/10 credit $11.89
I still have 7 spreads open and as stated above, they are currently profitable due to time decay, bid at $10.35. As stated above in my exit plan, I’m not in any rush to get out unless V has a large upside move… Stay tuned.