Q: How does this trade sell volatility? The trade was a
debit call spread. We bought a short term call spread and its value will erode as time goes by and will erode even faster if volatility does indeed come down. The VIX is in the middle to upper end of its recent range so it is very likely that it will come down, especially if the market rallies.
A: This is a volatility sale because we are selling the extrinsic premium of the short call which is ITM. The short call has much more extrinsic premium than the lower strike call. Therefore, as volatility shrinks (and I agree the VIX is in the middle of the range and is likely to come down - this is another reason I put on the trade) the extrinsic premium in the short call will decay more rapidly than the long call.
Q: You are stating that volatility will likely collapse through Thanksgiving. This alone will decrease the value of the short term options we are holding. If you expect volatility to collapse, wouldn't you rather sell short term options than buy short term options?
A: Yes, I would rather sell short term premium and that is exactly what we did by selling the juiced premium of the short call. Most people think of selling credit spreads to sell premium but it can be accomplished with Deep ITM Debit Spreads as well.
Q: This trade was released in the Weekly Trading Service but uses monthly options which are almost 4 weeks out, is this right?
A: The trade looks for a decrease in volatility and thereby a drop in option premium of the ITM short call. This volatility decrease is expected over the anticipated 1-2 week hold time.
Q: Is there a reason for using a debit spread instead of selling a credit spread?
A: This trade is looking for a volatility collapse through the Holiday period later this week and is is profitable as long as the stock stays above the short call which is deep ITM. Any sideways movement or rise in the stock will reduce volatility and increase the value of the long call (placed even deeper ITM than the short call) as it has a higher Delta than the short call. Additionally, the short call has more extrinsic premium which will decay quickly, thereby increasing the value of the debit spread.
As you can see, this
Deep ITM Debit Spread trade is much less directional than most people think when they hear the term "debit spread". Ample downside protection exists as the spread was executed deep ITM. As long as the stock stays above the short strike,
Theta decay characteristics, usually only associated with credit spreads, apply which will produce a profit for the trade.
However, what gives the
Deep ITM Debit Spread an advantage during periods of elevated option premiums is the
long Delta of the spread which will generate profits on top of the Theta decay of the short strike's extrinsic premium. This long Delta gives the trade the potential to be held for a shorter period as profits can be generated from 2 factors:
Theta decay and long
Delta exposure in the event of a reversal of the stock
BookingAlpha continues to outperform and deliver consistent Alpha:
+49.10% BookingAlpha Monthly Advisory
+22.37% YTD BookingAlpha Weekly Advisory
vs.
-5.17% YTD S&P 500
As you all know, BookingAlpha does ZERO advertising and instead depends solely upon what my subscribers say in reviews and referrals for growth. If BookingAlpha has provided you a good experience please take the time to tell others via Investimonials, Stock Gumshoe , or any other review site or medium you see fit. Thanks in advance!
Subscribe today and don't miss out on your next profit opportunity!
Enter promo code: BookingAlpha during account opening process for your FREE $50 bucks!
