Volatility effects on vertical spreads and butterflies
Implied Volatility on a ABC (theoretical pricing) Vertical
Strike +195
Strike -205
Volatility of the total package vertical with only Vol adjustments all other Greeks Being unchanged
30 Days out
30 Days out
(20%Vol) $4.10 (22%Vol) $4.20 (25%Vol) $4.38 (30%Vol) $4.68
60 Days Out
(20%Vol) $4.60 (22%Vol) $4.66 (25%Vol) $4.75 (30%Vol) $4.90 *
When you buy butterfly in a higher priced volatility environment, the butterfly's break even points will be priced farther apart, IE it covers more ground.
(a positive for the owner)
When you buy butterfly in a higher priced volatility environment, the butterfly's break even points will be priced farther apart, IE it covers more ground.
(a positive for the owner)
(for you visual learners, its kinda like this)
We are only Joking with the above Crude illustration, But those that work with options analytics will instantly see the resemblance.
His back legs are a high Vol butterfly
(you would want to own the one that covers more ground IE a larger break even)
His front legs are a low Vol Butterfly
(tighter break even, covers less ground) On The Flip Side.
The opposite would be true for a *SOLD* butterfly spread.
His back legs are a high Vol butterfly
(you would want to own the one that covers more ground IE a larger break even)
His front legs are a low Vol Butterfly
(tighter break even, covers less ground) On The Flip Side.
The opposite would be true for a *SOLD* butterfly spread.
**************************************
Reversing thought
Please take note of the WHITE LINE and the distance it covers relative to the second picture below.
This is a LOW VOL BUTTERFLY, SOLD (reverse if Bot)
APPROX 150-205 range or 55 points (this is a 10% vol reduction from actual)
HIGH VOL BUTTERFLY, Sold (reverse if Bot)
Again Note the white line relative to the above picture
APPROX 135-225 range or 90 points(this is a 10% vol increase from actual)
APPROX 135-225 range or 90 points(this is a 10% vol increase from actual)
If you didn't know the above was two different charts with a +-10% vol adjustment, One could easily assume the bottom chart was at the beginning of the butterfly's life, and the top one in the final stages of its life, which touches on an interesting mental approach to viewing Volatility-
"I consider Volatility as I would the fast forwarding or rewinding of time"- S.E.
Theta and Volatility are not the same thing, but are very much conceptually alike in their behavior and effects on pricing.
Aggressive market participants are what drives volatility, the calender ultimately dictates Theta.
(Only on Expiry)
(Theta) On the Final seconds of an options life- Into Close, all dreams, and hopium, is removed from the option pricing, and realization of what you own kicks in,- either it is worth something or it isn't.
But before this instant, explications can swell up pricing, but as we approach the deadline, this decay rate is also increasing, because we are rapidly approaching this point of a *realistic* where are we now, not where are we going pricing!
(Volatility) Any one willing to pay cross market and lift the offer, or pay cross market and hit the bid, are literally in essence raising and lowering vol with every order.
(Theta) On the Final seconds of an options life- Into Close, all dreams, and hopium, is removed from the option pricing, and realization of what you own kicks in,- either it is worth something or it isn't.
But before this instant, explications can swell up pricing, but as we approach the deadline, this decay rate is also increasing, because we are rapidly approaching this point of a *realistic* where are we now, not where are we going pricing!
(Volatility) Any one willing to pay cross market and lift the offer, or pay cross market and hit the bid, are literally in essence raising and lowering vol with every order.
This is Option supply and demand or order flow-
This the main factor in understanding Volatility from my view.
As well as any upcoming market assumptions,- like an earnings catalyst, or the overall underlying movement, but it all eventually goes back to FLOW.
How much Volatility will effect option prices is individual to each options strike, AKA its VEGA
Vega is illustrated like this:
If a particular option is priced at $1.50 (single leg)
and the current Volatility is 15% and contains a Vega of 0.15
If the underlying Implied Volatility moves from 15% to 16% (one percentage point increase)
This option would increase from $1.50 to $1.65 i.e. the price plus its Vega.
These moves are not uniform thought out the option chain, but related by the chains SKEW.
To approximate the theoretical daily movement in the underlying security simply divide its implied volatility by 19. ( 365 squared)
Skew is defined as the way of describing the differences in implied Volatility between different option strikes for a certain expiration cycle.
this began after the 1987 stock market crash and is now the norm.
(Prior to 1987 all implied volatility of a particular underlying, including different months traded at a single Vol.)
When you notice skew Steeping, it translated into people "hedging themselves"
When Skew is "Flattening" or Vix or Vxx or like products are not increasing the translation is the assumption that their is little fear, or already protected or less fear of a sell off.
"When Skew is steep, you get better Return on capital from selling puts, but worse return on Capital from Selling put spreads."
(T.P.)
We are out of TIME.
*Data source from TP thank you
