previous month. A graduated increasing or decreasing IV for each
consecutive expiration cycle is typical of the term structure of volatility.
Under normal circumstances, the front month is the most sensitive to
changes in IV. There are two reasons for this. First, front-month options are
typically the most actively traded. There is more buying and selling
pressure. Their IV is subject to more activity. Second, vegas are smaller for
options with fewer days until expiration. This means that for the same
monetary change in an option’s value, the IV needs to move more for short-
term options.
Exhibit 3.4 shows the same GM options and their corresponding vegas.
EXHIBIT 3.4 GM vegas.
If the value of the September 32.5 calls increases by $0.10, IV must rise
by 1 percentage point. If the February 32.5 calls increase by $0.10, IV must
rise 3 percentage points. As expiration approaches, the vega gets even
smaller. With seven days until expiration, the vega would be about 0.014.
This means IV would have to change about 7 points to change the call value
$0.10.