2010issue C1068-71
Modified butterfly and calendar spreads in high-priced names
Editorial framing: expensive directional options become a construction choice among verticals, modified butterflies, and same-strike calendars. Time decay, wing width, and implied-volatility skew shape how each spread is assembled.
- At-the-money options lose the most month-over-month time value in the final month before expiration, when theta accelerates remaining extrinsic value toward zero.
- A modified butterfly can be assembled from existing verticals by later selling a call or put spread, accepting extra interim risk for a lower net debit and more flexible directional exposure than a standalone vertical.
- Unlike an equidistant butterfly, a one-lot October 250/270/280 call fly keeps some upside profitability above the highest purchased strike because the short wing is tighter than the long bull-call wing.
- A same-strike calendar that is long the later expiration and short the nearer one reduces debit versus buying the longer option outright, because the near-term short captures faster theta.
Time decay in at-the-money options
An at-the-money option is a contract whose strike is nearest the current share price and is composed mostly of time value. These options lose the most month-over-month time value in the final month before expiration, because that period is when theta accelerates to reduce remaining extrinsic value toward zero. Theta is the daily rate at which an option loses value when other factors are held constant.
With other factors held constant, at-the-money option value scales with the square root of remaining time, so a four-month contract priced at 1.00 for 30 days is illustrated at 1.41, 1.73, and 2.00 as remaining life extends to two, three, and four months.
A longer-dated option can carry larger dollar exposure than a nearer expiration, while theta risk over the same window is greater for the contract that is about to expire. Vega and delta are described as stronger hazards for the longer-term contract. Vega is the sensitivity of option value to a change in implied volatility. Delta is the sensitivity of option value to a change in the underlying price.
Building a modified butterfly from verticals
A vertical spread is a same-expiration long and short option combination used as a directional core. A modified butterfly is a butterfly built from unequal wing widths, often by pairing a wider bull call spread with a tighter bear call spread.
A modified butterfly can be assembled from a trader's existing verticals by later selling a call or put spread, accepting extra interim risk in exchange for a lower net debit and more flexible directional exposure than a standalone vertical.
Unlike an equidistant butterfly, a one-lot October 250/270/280 call fly keeps some upside profitability above the highest purchased strike because the short wing is tighter than the long bull-call wing.
When upside implied-volatility skew steepens
Implied-volatility skew is the pattern of implied volatility across strikes, including steep upside call pricing. When upside implied volatility steepens as calls move further out of the money, the pricing is attributed to demand for upside protection and reduced supply from premium sellers, including buy-write traders who step back once opportunity cost becomes unattractive. A buy-write is owning shares and selling a call against them to collect premium.
Takeover candidates and popular growth stocks with smaller floats are cited as settings where this upside skew appears, because fast multi-strike advances make buy-writes, short straddles, and front-spreads difficult to manage amid negative gamma and wrong-way delta. A front-spread is a short-volatility structure that can become hard to manage when shares gap through several strikes.
Same-strike calendars
A calendar spread is a same-strike long and short option combination across two expirations. A same-strike calendar that is long the later expiration and short the nearer one is presented as another way to reduce debit versus buying the longer option outright, with the near-term short capturing faster theta while the longer option remains more sensitive to volatility and direction.
All readings on this track · 18 readings
- 2003Specify a butterfly as one range procedure
- 2006Index volatility alignment, skews, and butterfly construction
- 2006Oil proxies, volatility regimes, and bounded overlays
- 2007Pairing a double-diagonal overlay with an income butterfly
- 2008Range-bound butterfly debit versus iron credit
- 2008Iron butterfly payoff construction in volatile crude
- 2010Constructing directional out-of-the-money butterfly spreads
- 2010Modified butterfly and calendar spreads in high-priced names
- 2011Broken-wing put butterfly: credit, vega, and assignment
- 2013A live-cattle call butterfly is a different risk object than an outright call
- 2017Put butterfly payoff construction from an implied move and premium
- 2017One-day earnings volatility, ratio spreads and butterflies
- 2017Building a staggered broken-wing butterfly book
- 2017Below-the-money butterfly spreads sized by volatility regime
- 2018Why day-one option risk curves misread theta, calendars, and butterflies
- 2019An expected-value filter for defined-risk option spreads
- 2019Failed breakout as a setting for an out-of-the-money put butterfly
- 2020Limited-risk call butterfly construction in volatile oil