Entirely Extrinsic Expiration Day YEN
03/16/2011 9:06 pm Leave a comment
Position: FXY DIAGONAL (25% off ATM CALLS)
FXY is the Exchange-traded fund (ETF) for CurrencyShares Japanese Yen Trust. It tracks the value of the Yen by calculating its exchange rate against a basket of other currencies.
Over the last 7 days the value of the at the money (ATM) options has increased from 8.48% to 20.85%, an absolue increase of 12.37; much larger than normal.
[Click the graph for a larger view]
The spread in this example is constructed with the following options:
And the payout at expiration on 20 contracts looks like this:
[Click the graph for a larger view]
I’m leaving out the price slices because that is the end variable in a dynamic hedge.
Rationale for Spread: Sell shorter expiration CALLS to get more theta protection and buy closer ATM strikes to have larger proportionate deltas since as deltas converge to 50 they increase exponentially according to the curvature indicated by the gamma thus eliminating theta, delta, and gamma risk.
The dynamic part of this hedge is that since the short option has a different expiration from the long option it can (ideally) be bought back OTM before it expires. The volatility is high leading to high premium but more importantly the CALL is OTM and today is expiration day. Selling 1 FXY 11-MAR 127 CALL is equivalent to telling you I want to pay you $24.50 that you can keep if FXY doesn’t close +2.13 tomorrow. That would be half the move it made this entire week.
Zevon's Log 