you can do this type of analysis outside of
trading hours so it can become a potential
plan for the next trading day.
CRUSH TIME DECAY
Speaking of time, that’s where the next
step—portfolio theta—comes into play. The
nice thing about portfolio theta is that anyone
can add them together and not weight them.
That’s because one day passing is the same
no matter what’s being traded. And theta is a
dollar term that measures the decay in the
extrinsic value* of a portfolio’s options. Theta, then, is in the same scale for all products,
can compare theta directly between trades
without adjusting them again for underlying
price, like you would do for delta.
For portfolio theta, what’s key is time to
expiration. If the portfolio’s theta is $212, the
portfolio would theoretically make $212 over
the next day due to time decay, if nothing else
changes. Generally, theta is highest the closer
an option is to expiration. Is that positive theta
high because most options in the portfolio
are expiring in the coming days? Or are the
options diversified over time, with some close
to expiration with very high theoretical theta,
and others further from expiration with lower
By balancing theta over time, you avoid big
theta swings as expiration approaches and
passes, while attempting to diversify across
events. If you see most of your positive theta
positions clustered around one expiration,
or around a significant news event, your
short options might all go
against you at the same time
and wipe out your theta. You
could attempt to roll short
options to nearer or further
expirations to spread theta
out. Rolling those short
options out to further expirations can pre-
serve the same trading logic of the original
position, while maintaining a steadier theta
for your account.
A quick way to check for earnings events
on a symbol is to project future dates on
Charts. Click on the Style button on the
Chart, then choose Settings from the dropdown menu. Next, click on Time axis, and
find the Expansion area (Figure 2). Set it to
60, for example. That will expand the right-hand side of the chart and let you see any
event announcements coming up.
Finally, check your portfolio’s vega. If it’s
negative 938, that means your portfolio
would theoretically lose $938 all else equal, if
the implied vol of each option in your portfolio rose by exactly one percentage point.
Vegas are added together, just like theta.
The only warning is that the implied vols of
the stocks and indices in your portfolio may
not always move up and down at the same
time. So, portfolio vega is typically a rough
estimate. But if the market crashes and sends
VIX through the roof, it’s possible that the
implied volatilities of all symbols in your
portfolio might go up, too.
If you have a lot of short vega, see where
the VIX is. If it’s low, ask yourself if you want
to be short volatility when the risk of a spike
may be high. To reduce short vega, consider
adding long options in further expirations to
create calendars out of some short options.
On the other hand, long delta trades in VIX
Just like hedging delta risk, identify the
one trade—whether it’s a positive vega index
trade or a VIX trade—that will potentially
neutralize the short vegas if necessary.
Keep in mind that all these adjustments incur
commissions, so making a lot of them can
drive commissions higher. But the goal of this
exercise is to get you to step back, look at the
aggregate delta, theta, and vega risks of your
total portfolio, and create a plan to bring them
back to where you’re comfortable. When you
need the hedge, chances are the markets will
be moving, and you’ll want to focus on that.
Tear a page from the market maker’s playbook. Do your homework the night before,
and take action to attempt to manage risk
and stop the bleeding when needed. Above
all, consider all the moving parts of your
book. Frankenstein’s shinbone connected to
his knee bone, so he was careful to nurture
Thomas Preston is not a representative of
TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the
author and may not be reflective of those held by
TD Ameritrade, Inc.
Naked option strategies involve the highest
amount of risk and are only appropriate for traders
with the highest risk tolerance. Examples presented in this piece are for educational and illustrative
FIGURE 2: Any announcements ahead? You can tell your charts to display upcoming earnings releases by setting the expansion area to a specific number of days.
Source: TD Ameritrade. For illustrative purposes only.
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