RUT Calendar 5-15

The feature trade for this month is moving along, but still not yielding any profits. So far the overall campaign is down a whopping $174, which isn't bad considering the loss of implied volatility (IV) we've seen. Remember, Calendars are Vega (the measure of volatility risk) POSITIVE. In other words, they profit when IV increases, and lose when it decreases.

Why is that you say? Mainly because volatility changes operate on extrinsic value (that portion of value OUT of the money); AND extrinsic - or time - value is more exaggerated when there is more time in the option. In other words, the farther out in time an options expiration date is, the greater the changes in IV will affect the price. Now for calendars, we are typically SHORT a short term option, and LONG a long term option.

So, what happens when IV increases? The short term option decreases and the long term value increases. Do they balance each other out? No, because the one further out in time changes at a greater rate. Let's use our current trade as an example... We currently have on a triple calendar at strikes of 460, 500, 540. At each strike we are short the June options (we sold them) and long the July options (we bought them). Here are the Vega values for each of these:

• The sum of the June SHORT position VEGA is -142. What that means for every increase in implied volatility (IV) of one point, we lose $142.00; and for every decrease in IV of one point we gain $142.00.


• The sum of the July LONG position VEGA is +209. This is positive Vega, so for every increase in IV we increase in value.


• The NET of these two (i.e. the value of the spread) is +67 (just add +209-142). So the net is POSITIVE VEGA. In other words, when IV goes up the value of the spread goes up.

I'm not trying to be overly technical, but it pays to know why you make money, and why you lose money. This is why I make such a big deal about watching the RVX - the index which tracks the IV of the RUT. The interesting thing is that it's just about at the same spot it was when we entered the trade. It's down a little, but not much... about 1/2 point. You can see by the chart the most of our current deficit is due to price moving down substantially.

We will continue to track this and attempt to manage it to a successful and profitable conclusion.

Good Trading...