32 lines
2.2 KiB
Plaintext
32 lines
2.2 KiB
Plaintext
Verticals and Volatility
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The IV component of a vertical spread, although small compared with that
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of an outright call or put, is still important—especially for large traders with
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low margin and low commissions who can capitalize on small price
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changes efficiently. Whether it’s a call spread or a put spread, a credit
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spread or a debit spread, if the underlying is at the short option’s strike, the
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spread will have a net negative vega. If the underlying is at the long
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option’s strike, the spread will have positive vega. Because of this
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characteristic, there are three possible volatility plays with vertical spreads:
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speculating on IV changes when the underlying remains constant, profiting
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from IV changes resulting from movement of the underlying, and special
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volatility situations.
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Vertical spreads offer a limited-risk way to speculate on volatility changes
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when the underlying remains fairly constant. But when the intent of a
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vertical spread is to benefit from vega, one must always consider the delta
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—it’s the bigger risk. Chapter 13 discusses ways to manage this risk by
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hedging with stock, a strategy called delta-neutral trading.
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Non-delta-neutral traders may speculate on vol with vertical spreads by
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assuming some delta risk. Traders whose forecast is vega bearish will sell
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the option with the strike closest to where the underlying is trading—that is,
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the ATM option—and buy an OTM strike. Traders would lean with their
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directional bias by choosing either a call spread or a put spread. As risk
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managers, the traders balance the volatility stance being taken against the
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additional risk of delta. Again, in this scenario, delta can hurt much more
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than help.
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In the ExxonMobil bull put spread example, the trader would sell the 80-
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strike put if ExxonMobil were around $80 a share. In this case, if the stock
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didn’t move as time passed, theta would benefit from historical volatility
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being’s low—that is, from little stock movement. At first, the benefit would
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be only 0.004 per day, speeding up as expiration nears. And if implied
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volatility decreased, the trader would profit 0.04 for every 1 percent decline
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in IV. Small directional moves upward help a little. But in the long run, |