Calendar Spread Placed on BKX is Instructional

01/11/2010 11:02 am EST


I recently mentioned that the bank index (BKX) was looking strong following a long period of stagnation and we saw a big spread trade on the BKX last week that is instructive.

According to livevolpro data, there was a spread that traded 3880 times on the ISE exchange on the BKX index at around 2:45 pm EST.  This was a horizontal calendar spread with the January 45 call and the February 45 call, with the BKX around 45.30 at the time.

Based upon the prices that the spread was done (0.96 on the January call, 1.91 on the February call), it looks to me like this large trader bought the January calls and sold the February calls. The mid price on the January calls was 92.5 cents, and for the February calls, it was 1.95. This makes the spread worth around 1.03 at the time, and they look to have sold it for about 0.96 net. They gave the market makers around 0.07 worth of "edge" based on these approximations.

What does this calendar spread look like on a profit/loss graph? Well, this is a long gamma, long theta, short vega trade assuming this is a stand-alone horizontal calendar spread. Remember, these January options expire on the 15th—they are paying time premium on the January calls, which were 0.30 in the money at the time (therefore, 0.66 time premium/volatility).

Considering the long gamma/theta and short vega, it looks like they need the stock to move quickly. A rise up would be the best-case scenario, because then implied volatilty/vega would go down (usually when stocks rise, option volatility drops).

For example, using OptionVue, if the stock remained flat at 45.30 and volatility also stayed flat through January 15 expiration, this position would lose around $270,000. This is due to the rapid decay to zero in the time premium in the January calls, while the February calls will still hold value. 

However, if the BKX rallies to 47.50 on January expiration, for example, this position may gain around $40k.  And if volatility also drops 5% on the options, you then are up to a theoretical $116,000 profit. On the downside, if BKX drops to 42.50 on expiration, this makes a theoretical profit of $39,000 with flat volatility. However, if volatility then rises 5% (usually implied volatility rises when a stock drops), it turns into a $39,000 loss.

You can see that these horizontal calendar spreads are fairly complex just as a stand-alone position. There also is the possibility that this is a hedge or combination with another position on the BKX, its options, or other indexes, ETFs, or stocks.

It will be interesting to see how this trade (based on the information we have) plays out. 

A recent chart of the BKX at the time of the option trade is below.

Click to Enlarge

By Moby Waller of

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