Replies to post #2070 on Options: Dispersions and Volatility Spreads

[WinLoseOrDraw]

Preview for XOM/Dow convergence trade using EOD numbers...

Looking for 1/2 the overperformance of XOM vs Dow to be given back. Targets look like

 
   Scenario                XOM        DIA 
   ------------------------------------------- 
   1. XOM -20%, Dow flat   60->48     110 
   2. Both converge 10%    60->54     110->122 
   3. XOM flat, Dow +20%   60         110->133 
 

Straight shot:

 
   DIA Sep06 120C @ 0.95  
   XOM Oct06  55P @ 1.80 (x2)

Max loss is the premiums (1.80*2 + 0.95) -> 4.55. It gets tagged if *both* XOM ends above 55 and Dow below 12,000.
By scenario:

 
   1. (55-48)*2 - 4.55 = +9.45 
   2. (55-54)*2 + (122-120) - 4.55 = -0.55 
   3. (133-120) - 4.55 = +8.45

Alternately, use a spread for the XOM position.

 
   DIA Sep06 120C @ 0.95 
   XOM Oct06 55P/50P @ (1.80 - 0.75) = 1.05 (x2)

Max loss now 3.05, scenarios 1-3 drop to +6.95, +0.95 and +9.95.

Using ATMs max loss is the premiums, which are (3.60*2 + 5.00) -> 12.20.

 
   1. (60-48)*2 - 12.20 = +11.80 
   2. (60-54)*2 + (122-110) - 12.20 = +10.80 
   3. (133-110) - 12.20 = +10.80