better off selling the bigger vega of the straddle. Here, though, he wants to
see the premium at zero at expiration, so the strangle serves his purposes
better. What he is most concerned about are the breakevens—in this case,
98.20 and 111.8. The straddle has closer break-even points, of $99.60 and
$110.40.
Despite the fact that in this case, John is not really trading the greeks or
IV per se, they still play an important role in his trade. First, he can use
theta to plan the best strangle to trade. In this case, he sells the three-week
strangle because it has the highest theta of the available months. The second
month strangle has a −0.71 theta, and the third month has a −0.58 theta.
With strangles, because the options are OTM, this disparity in theta among
the tradable months may not always be the case. But for this trade, if he is
still bearish on realized volatility after expiration, John can sell the next
month when these options expire.
Certainly, he will monitor his risk by watching delta and gamma. These
are his best measures of directional exposure. He will consider implied
volatility in the decision-making process, too. An implied volatility
significantly higher than the realized volatility can be a red flag that the
market expects something to happen, but there’s a bigger payoff if there is
no significant volatility. An IV significantly lower than the realized can
indicate the risk of selling options too cheaply: the premium received is not
high enough, based on how much the stock has been moving. Ideally, the
IV should be above the realized volatility by between 2 and 20 percent,
perhaps more for highly speculative traders.