35 lines
2.4 KiB
Plaintext
35 lines
2.4 KiB
Plaintext
The Big V
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Gamma and theta are not alone in the straddle buyer’s thoughts. Vega is a
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major consideration for a straddle buyer, as well. In a straddle, there are two
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long options of the same strike, which means double the vega risk of a
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single-leg trade at that strike. With no short options in this spread, the
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implied-volatility exposure is concentrated. For example, if the call has a
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vega of 0.05, the put’s vega at that same strike will also be about 0.05. This
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means that buying one straddle gives the trader exposure of around 10 cents
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per implied volatility (IV) point. If IV rises by one point, the trader makes
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$10 per one-lot straddle, $20 for two points, and so on. If IV falls one point,
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the trader loses $10 per straddle, $20 for two points, and so on. Traders who
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want maximum positive exposure to volatility find it in long straddles.
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This strategy is a prime example of the marriage of implied and realized
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volatility. Traders who buy straddles because they are bullish on realized
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volatility will also have bullish positions in implied volatility—like it or
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not. With this in mind, traders must take care to buy gamma via a straddle
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that it is not too expensive in terms of the implied volatility. A winning
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gamma trade can quickly become a loser because of implied volatility.
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Likewise, traders buying straddles to speculate on an increase in implied
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volatility must take the theta risk of the trade very seriously. Time can eat
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away all a trade’s vega profits and more. Realized and implied exposure go
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hand in hand.
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The relationship between gamma and vega depends on, among other
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things, the time to expiration. Traders have some control over the amount of
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gamma relative to the amount of vega by choosing which expiration month
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to trade. The shorter the time until expiration, the higher the gammas and
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the lower the vegas of ATM options. Gamma traders may be better served
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by buying short-term contracts that coincide with the period of perceived
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high stock volatility.
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If the intent of the straddle is to profit from vega, the choice of the month
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to trade depends on which month’s volatility is perceived to be too high or
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too low. If, for example, the front-month IV looks low compared with
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historical IV, current and historical realized volatility, and the expected
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future volatility, but the back months’ IVs are higher and more in line with
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these other metrics, there would be no point in buying the back-month |