Oil Time Spread
All examples are as of March 23, 2011.
This is an example of a type of trade that option professionals love. Many amateur investors do not like to buy options that are near expiration. In our language, the Theta decay is too fast. The pros know that many times this is exactly what you should be doing. Being long a near dated option lets you reap outsized gains of any price movement. Of course this will not work if the price movement dies down. To guard against this they sometimes sell a longer dated option. They reason that if actual vol dies down, the implied vol in the long dated option will fall also - giving them a gain on the Vega.
This trade involved the following:
Long 1000 Apr 15, 2011 Calls, strike of $41
Short 1000 Oct 21, 2011 Calls, strike of $42
The top graph shows the gain/loss on this position. As you might expect, the payout is V-shaped. If the market makes a big move in either direction, you win. So if another mideastern way breaks out (or one is settled) you are good.
What if nothing happens. It is possible that that realized vol will fall and the implied vol in the options will stay high. But normally implied vol bears a pretty close relation to actual vol. So say the price of USO doesn't move and implied vol declines by 20% (the Green line). You actually make money! The profit on the long date option will overwhelm the loss on the near one.
The second graph is of the trade's Vega exposure (the gain/loss of a 1% increase in implied volatility). Note that this trade is short Vega. At current prices, it gains $86 for every 1% decline in vol. This is what you expect will protect you in a stagnent market.
The authors of this app realize that this trades may not be appropriate for novice traders. However, if you play around with a few like this, and let OptionsPosition tell you about you risk, you may soon be imitating the big boys.