This segment explains what a trader can do to offset some of the vega (implied volatility) risk in directional trades or in a directionally biased portfolio. The study revealed here should give you the confidence to act.
The October 19, 2015 segment of Market Measures discussed Vega, especially in non-directional trading. This segment follows up on that one and explains how Vega can add to losses in certain situations and what can be done to minimize such losses.
Negative vega represents the theoretical loss of a short option position after a 1% increase in IV. Short stock is sometimes used to offset an increase in IV (since IV often increases after sell-offs). A graph was displayed of a theoretical put option price based on implied volatility (IV).
A premium seller who is short puts will be hurt if the underlying goes down not only by the directional move but by the increase in IV. What can be done to offset that?
An example of the delta and vega offsets were displayed. The example included the short put delta, short put vega, theoretical risk with a 2-point SPY (S&P 500 ETF) decrease and the amount of shares to offset delta and vega.
An example of a 16 delta short put with a vega of -20 was displayed. The example showed the number of short puts and the number of short shares for the two strategies of a short put and a short put with vega and delta offset.
A table displayed the results of both strategies. The table included the average P/L and max loss of both the short put and the short put with vega and delta offset.
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista along with special guest Chris Butler (from our research team) for the takeaways, the study results and other important information about understanding vega and offsetting volatility risk for directional and short premium plays.
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