Understanding the implications of skew can help an option trader make better, and more profitable trading decisions, notes Greg Loehr of OptionsBuzz.com.
When is calendar skew important? When understanding it can profit you 290% in two weeks—like the Facebook (FB) calendar we found in the live trading session. When is it important? Basically, all the time; especially if you don’t understand it. And if you don’t understand it, then you shouldn’t trade calendars.
When the concept of skew starts to make sense, then you can put it to work in analyzing, which trades might be worth entering, and which trading ideas you should walk away from. For instance, potential calendar trades start to become less and less enticing when a large positive skew is present between the options. This concept really leads retail traders astray because it’s not completely understood.
This is what we saw in FB when the Feb 1 expiration 30 puts with a 75% volatility, and the Feb 8 30 puts with a 66% vol, created a skew of 14%. With this large positive skew exceeding a general guideline there was reason to be skeptical of this calendar, which only cost 10 cents.
But after spending some time in the live class looking at every angle of this trade, we concluded that the calendar was actually a good potential trading idea.
Two weeks later and the result of this calendar was a huge win with the trade netting 290%. The trade survived an earnings announcement, and the resulting volatility crush—both of which are usually killers for calendar spreads. Was there perhaps a bit of luck involved in the trade turning out so well? Probably. But to paraphrase Louis Pasteur “chance favors the prepared trader.”
By Greg Loehr of OptionsBuzz.com