If long straddle vega works when vol is rising, shouldn’t the negative vega from a short
straddle work when vol drops? On one hand,
it should. But a short straddle may bring
undefined risk potential. For example, let’s
say earnings come out and vol crumbles as
the stock moves big in either direction. You’ll
likely profit from your trade’s short vega,
but you could end up being short a 100-delta
option, which could cost you. It’s like you’re
trading synthetic stock at that point—not
what you want if you’re trading vega.
Some other spreads have defined risk,
and they can still profit from a collapse in
vol: short verticals, long butterflies, short
iron condors, and short iron butterflies,
to name a few. Unlike straddles (or single
options), these spreads combine options
with positive and negative vega, which you
might think will cancel out the vega. But
the net vega depends on your strike choices.
How’s that? Keep in mind that different
strikes have different amounts of vega.
At-the-money (ATM) options have the
highest. Vega tapers off toward zero as the
option goes out of the money (OTM). This
difference in vega levels means spreads
with strikes that are further apart can have a
higher net vega. Spreads with strikes closer
together will have smaller net-vega values.
One strategy for playing a volatility col-
lapse is with a short iron butterfly. But note
the difference strike selection makes be-
tween two iron butterflies using the theo-
retical options prices in Table 1.
The 215-220-225 short iron butterfly is
short the 220 straddle for a credit of $15.85
($7.85 credit + $8 credit) and long the 215-
225 strangle for a debit of $12 ($6.40 debit +
$5.60 debit). This nets a combined credit of
$3.85 ($15.85 – $12), less transaction costs.
Sounds like a big, juicy credit on a trade
SUMMER 2019 | tdameritrade.com | 27
with a maximum
value of $5. But the
vega for this trade
is only $0.02. You
calculate this by
taking the short
$0.44 of vega
for the straddle
($0.22 + $0.22)
and netting it with
the strangle vega
of $0.42 ($0.21 +
$0.21). (So, it’s not
really a vega trade.)
Moving on, if you
spread the strikes
apart by select-
ing the 200-240
strangle as the long
options for a net debit of $3.85 ($2.45 + $1.40
plus transaction costs), the credit for the iron
butterfly jumps to $12 for a trade that can be
worth $20. Yet, now the vega for the further
OTM strangle drops to $0.30 ($0.15 + $0.15).
This brings the vega for the 200-220-240
iron butterfly to $0.14 ($0.44 – $0.30).
By widening out the strikes, the vega
exposure of the 200-220-240 iron butterfly is seven times the vega exposure of the
215-220-225 iron butterfly. Of course, these
trades have different net risks, break-even
points, and more. If this strategy doesn’t fit
the bill, possibly consider something like
the 200-210-230-240 iron condor, or any
combination thereof. But consider whether
your strategy is designed to profit from a
change in vol.
IN THE FINAL ANALYSIS, DON’T LET VEGA
become an overlooked or confused greek in
your trades. It’s a great tool for understanding your exposure to vol. And when you
think vol changes are on the horizon, vega
can help you craft a strategy designed to
tackle the situation.
For more on the risks of trading and trading options,
see page 38, #1– 2.
platform, go to
the Monitor tab
> Activity and
Positions > and
Vega to columns.
You could choose
to beta weight
TABLE 1: Different strikes, different vega. It’s a good idea to analyze vega before deciding which strategy
to use. For illustrative purposes only.
0.15 21.80 22.70 200 2. 30 2.45 0.15
0.17 17.85 18.45 205 3. 30 3.50 0.17
0.19 13.85 14.70 210 4.50 4.60 0.19
0.21 10.80 11. 20 215 6. 20 6. 40 0.21
0.22 7.85 8. 10 220 8.00 8. 30 0.22
0.21 5. 40 5.60 225 10.80 11. 20 0.21
0.19 3.50 3.70 230 13.65 14. 40 0.19
0.17 2.05 2. 25 234 17. 10 18. 10 0.17
0.15 1.25 1.40 240 21. 10 22. 40 0.15
IF TRADING VOL
IS PART OF
IS THAT VEGA