Yesterday we highlighted the major difference between weekly implied vol and June regular vol in HPQ and offered up two calendar trades. To recap, here were the trades and the rationale:
Hypothetical Bullish:
Buy the May22nd/ June 36 call calendar for .20
– Sell 1 May22nd 36 call at .17
– Buy 1 June regular 22 call for .37
Hypothetical Bearish:
Buy the May22nd/ June 31 put calendar for .20
– Sell 1 May22nd 31 put at .14
– Buy 1 June regular 31 put for .34
Rationale – Even though the weekly options are dollar cheap, the sale at nearly 100 vol points higher than the June options covers a lot of potential scenarios for the stock. On each trade the desired result is a move towards that strike without going too far through. Even sideways movement in the stock is likely to result in a very small profit on each trade. The nightmare scenario is a massive outsized move in either direction, but with only .20 at risk on each trade it’s a fairly well defined risk.
The stock is higher today on the results. The bullish structure is profitable and the bearish one is trading at a loss. But the losses from the bearish are not equivalent to the gains of the bullish and that is a direct result of that difference in vol we highlighted. In other words, it’s great if you played the event from the bullish side, but had one simply taken a neutral directional view and done both the trades, the results would still be profitable. Both trades cost .20. The bullish trade is a double, trading around .40 the bearish one is about a 50% loss, trading around 10c. Both trades together would have net about a 10c gain with no directional view. Of course that’s a lot of strikes to trade and commissions are a factor.
Looking more closely, the vol in the front month was essentially binary and was totally dependent on the stock either being within range of its expected move. Since that turned out to be the case those weekly call and puts sales go to zero, and what is left is the June regular options whose only factor is just how much that month’s vol comes in. June came in about 9 points, which is what we expected. If the stock hadn’t moved at all that would have likely resulted in small gains on both trades.
I wanted to go over this mainly due to the nature of our new section on the site of short premium strategies. The calendar trade isn’t in itself net short premium, but in these cases the difference in the vol between front and farther back expirations is essentially a vol crush play.