This entry was posted on Tuesday, April 7th, 2009 at 6:32 pm and is filed under double calendar spreads, how to trade options, learn option trading, option trading strategies, The Greeks. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
Over this last couple of posts I’ve attempted to provide you with an overview on a couple of the Greeks, indispensable indicators in showing you how to trade options “by the numbers”.
I will today wrap up our introduction to the Greeks by discussing Vega and Ro and with regards the former, we”ll return and take another look at the IWM index.
Of the variables which affect the price of an option Vega is certainly one of the most important and is without doubt the most powerful of the Greeks. Vega measures how much an option will change in value because of a one point change in volatility. You may well see a significant change in your position because of a change in volatility.
Back to the IWM. Several days have now elapsed since we last looked at Delta, Gamma and Theta. As at today these are reading at 39.38, -20.03 and 5.15. Do take a look back at the last two posts should you require an explanation of these readings. In this post our focus will be on Vega. Vega shows up as 23.33. So, this is telling us that for every $1 change in increase in the Vega, (or volatility of the market) we will gain an additional $23.33 in profit. 23.33 is a relatively neutral figure which is what we want to see.
We can observe the measure of volatility in the market by tracking the $VIX index. This reflects the measurement of the number of puts being purchased on the CBOE (Chicago Board Options Exchange). As a general rule of thumb, when volatility goes up stocks go down and conversely when volatility goes down then stocks go up. Volatility is a reflection of fear in the market .. when we see more people buying puts that is because they fear that prices will decline .. the more puts purchased, the greater the increases in the levels of volatility. If we compare the graph of the $VIX with that for the IWM (or indeed any of the other indexes) we will see that volatility runs in exactly the opposite direction of market activity. When the $VIX drops back .. the market is seen to be going up and when it goes up, the market moves down.
The IWM positions I have on – a double calendar spread, are short positions – where I am selling in the front month and protecting myself with the calls and puts purchased in the following month. The Vega positions I have on mean that as long as the market continues to rise I will make money and if it drops back I will lose money.
Just a very quick word on Ro. This is not an “active” Greek like the others, but is simply the measurement of the change in value of an option relative to a one point change in interest rates. Interest is used as a comparative because when you purchase an option you are spending money which might otherwise be sitting in an account earning interest.
With a little less volatility in the market things are settling a bit and “touch wood” I will not have to make any further adjustments. As at today, on the spreads I have on – current profit is $752.50 for the month, on a margin of $3,800. If I should be able to hold this position, maximum potential profit is $1,640.44, although sensibly I will be closing off most of the positions over this next 4-5 days. Strange things have been known to happen during the week leading up to expiry!
Even if this current figure of $752.50 was to remain unchanged (and yes, it could go down) that is a 30.47% return on margin .. not for a year .. but for a month! Gotta be better than leaving you money in a bank account getting a paltry 5% a year don’t you think?
Do remember that here we are learning how to trade options as a business and that means managing by the numbers. And, to whom do we turn to get the numbers .. yep, you guessed it .. the Greeks!