Options Trading Mastery: Effects of Volatility on the Time Spread

August 17, 2010 by  
Filed under Option Trading

When purchasing a time spread, the investor should pay attention to not only the movement of the stock price, but also the movement of volatility. It plays a very large roll in the price of a time spread, which is an excellent way to take advantage of anticipated volatility movements in a hedged fashion.
Option Volatility
Since the time spread is composed of two options, the investor should understand the role of volatility in options as well as in time spreads. Let us start with option volatility.
We measure an option’s volatility component by a term called Vega. Vega, one of the components of the pricing model, measures how much an option’s price will change with a one-point (or tick) change in implied volatility. Based on present data, the pricing model assigns the Vega for each option at different strikes, different months and different prices of the stock.
Vega is always given in dollars per one tick volatility change. If an option is worth $1. 00 at a 35 implied volatility and it has a . 05 Vega, then the option will be worth $1. 05 if implied volatility were to increase to 36 (up one tick) and $. 95 if the implied volatility were to decrease to 34 (down one tick).
Keep these facts in mind as we continue to discuss Vega:
1. Vega measures how much an option price will change as volatility changes.
2. Vega increases as you look at future months and decreases as you approach expiration.
3. Vega is highest in the at-the-money options.
4. Vega is a strike-based number. It applies whether the strike is a call or a put.
5. Vega increases as volatility increases and decreases as volatility decreases.
It is important to note that an option’s volatility sensitivity increases with more time to expiration. Further out-month options have higher Vegas than the Vegas of the near term options. The further out you go over time, the higher the Vegas become. Although increasing, they do not progress in a linear manner. When you check the same strike price out over future months you will notice that Vega values increase as you move out over future months.
The at-the-money strike in any month will have the highest Vega. As you move away from the at-the-money strike in either direction, the Vega values decrease and continue to decrease the further away you get from the at-the-money strike. Remember, Vega (an option’s volatility component value) is highest in at-the-money, out-month options. Vega decreases the closer you get to expiration and the further away you move from the at-the-money strike.
The chart below shows Vega values for QCOM options. Observe the important elements. The stock price is constant at 68. 5. Volatility is constant at 40. Time progresses from June to January. Finally, the strike price changes from 50 through 80. Notice the increasing pattern as you go out over time and how the value decreases as you move away from the at-the-money strike.
Chart 3- Vega
Stock Price 68. 5 Vol. 40
Strike June July October January
50 0 . 008 . 064 . 114
55 . 004 . 030 . 102 . 153
60 . 023 . 063 . 135 . 184
65 . 053 . 090 . 157 . 205
70 . 056 . 094 . 165 . 215
75 . 032 . 077 . 154 . 213
80 . 011 . 052 . 142 . 203
Another important fact about Vega is that it is a strike-based number. This means that the Vega number does not differentiate between put and call. Vega tells the volatility sensitivity of the strike regardless of whether you are looking at puts or calls. Therefore, the Vega number of a call and its corresponding put are identical.
The chart below shows the Vega values for calls and the corresponding puts. As you can see, these values match up in every instance.
Chart 6
Strike Price-Call Vega-Put Vega
June
60 . 023 . 023
65 . 053 . 053
70 . 056 . 056
July
60 . 063 . 063
65 . 090 . 090
70 . 094 . 094
October
60 . 135 . 135
65 . 157 . 157
70 . 165 . 165
January
60 . 184 . 184
65 . 205 . 205
70 . 215 . 215
Vega can also calculate how much a specific option’s price will change with a movement in implied volatility. You simply count how many volatility ticks implied volatility has moved. Multiply that number times the Vega and either add it (if volatility increased) to the option’s present value or subtract it (if volatility decreased) from the option’s present value to obtain the option’s new value under the new volatility assumption. The calculation works on individual options and can analyze the value of the time spread.
Apply Vega to Time Spreads
Now, let us apply the concepts of Vega to the Time Spread. When you apply the Vega concept to time spreads, you observe that as implied volatility increases, the value of the time spread increases. This is because the out-month option, with the higher Vega will increase more than the closer month option with the lower Vega. That widens or increases the spread.
The chart below shows a time spread and its reaction to increasing volatility. Each time that implied volatility increases, the value of the time spreads increase. This increase would naturally favor the buyer.
Chart 4
Stock Price $ Vol. June / July 65 Oct / July 65
65. 5 30 1. 09 2. 09
65. 5 40 1. 43 2. 75
65. 5 50 1. 77 3. 41
65. 5 60 2. 11 4. 05
65. 5 70 2. 49 4. 60
If an investor bought the time spread at low volatility and within a few weeks volatility had increased and pushed the spread price higher, the investor could sell the spread at a profit even before expiration.
Of course, the Vega can also demonstrate the opposing effect. As implied volatility decreases, the spread tightens or decreases in value. As volatility comes down, the out-month option with its higher Vega will lose value more quickly than will the nearer month option with its lower Vega. In the chart below, you will see how decreasing volatility affects the time spread’s value.
Chart 5
Stock Price $ Vol. June / July 65 Oct / July 65
65. 5 70 2. 49 4. 60
65. 5 60 2. 11 4. 05
65. 5 50 1. 77 3. 41
65. 5 40 1. 43 2. 75
65. 5 30 1. 09 2. 09
Glance back to Charts 4 and 5. Take note that the stock price is constant. The changes in the price of the spreads are due to the change in volatility.
We discussed how to use Vega to calculate an option’s price when volatility changes. The same calculation method works for time spreads but the calculation is slightly more difficult.

Ron Ianieri is currently Chief Options Strategist at The Options University, an educational company that teaches investors how to make consistent profits using options while limiting risk. For more information please contact The Options University at http://www. optionsuniversity. com or 866-561-8227

How to Calculate the Volatility of the Spread in Options Trading

August 14, 2010 by  
Filed under Option Trading

In order to be able to calculate the volatileness of propagacià ³ n, we must equal volatilenesses of the options individuales.& #13; First of all, we are going to move of June of calls being moved the implÃcita volatileness of June by 40 to 36, one disminucià ³ n of four garrapatas volatileness. Four volatileness of the garrapatas, multiplied by a fertile valley of. 05 by tick give a value us of $. 20. To continuacià ³ n we reduced $. 20 of June the present value of 70 opcià ³ n of $ 2. 00 and obtains a 36 value of $ 1. 80 to volatileness. Now the two options are evaluated in a base volatileness igual.& #13; As far as this first adjustment in which trasladà ³ the 70 of June of volatileness up to 36 from 40, we have a value of $ 1. 80 to 36 volatileness. 40 August call volatileness has a value of $ 3. 00 to 36. Therefore propagacià ³ n valdrÃ$ 1. 20 to 36 volatilidad.& #13; If you want to move August 70, solicits that, you tomarÃa the fertile valley August of call of 70. 08 and multiply by four the difference of implÃcita volatileness of garrapatas.& #13; This gives a value him of $. 32 that must be añadir to the present value of August of 70 calls with the purpose of to take it until an equal volatileness (40) with 70 June of call. To add $. 32 to 70 of August of call give to 3 dà ³ him lares. Value of 32 in the level of volatileness of the new ones of 40 that is the same level of volatileness that June 40 llamadas.& #13; Now, ours expansià ³ n is a value of $ 1. 32 to 40 volatileness. August 70 calls of $ 3. 32 except 70 June to two the calls of dà ³ lares. 00 to fix the price of propagacià ³ n to 40 volatilidad.& #13; ³ n does not make any difference of opcià that to move. The point is to establish the same level of volatileness for both options. Then already estÃready to compare apples with apples and the options to the options for a value of propagacià exact ³ n and level of volatilidad.& #13; Since now we have an equal base of volatileness, we can calculate propagacià ³ n of fertile valley taking the difference between opcià ³ n from two fertile valleys individual. In the previous example, propagacià ³ n fertile valley is. 03 (. 08 -. 05). The fertile valley of propagacià ³ n calculates finding the difference between those of the fertile valley of the two individual options, because in the time of propagacià ³ n, that pasarÃlong time one opcià ³ n and cuts the other opcià ³ n.& #13; As volatileness moves a garrapata, you ganarÃthe value of fertile valley one of the options at the same time of losing the value fertile valley of the other. Therefore propagacià ³ n of fertile valley must be equal to the difference between the fertile valley of two options. Therefore, ours expansià ³ n is a value of $ 1. 20 to 36 with a volatileness. 03 fertile valley or $ 1. 32 to 40 with a volatileness. 03 vega.& #13; Returning to our value difusià original ³ n of $ 1. 00 with a fertile valley from. 03, now we can calculate the volatileness of which propagan.& #13; We know the difference is a value of $ 1. 20 to 36 of volatileness with a fertile valley of. 03. Therefore, we can suppose that the commerce of difusià ³ n from $ 1. 00 deberÃto develop a commercial activity in a volatileness smaller than 36.& #13; In order to know cuÃnto mÃs under is in the first place to take care of the difference both enters values extended and that is of $. 20 ($ 1. 20 to 36 volatileness less $ 1. 00 a? Volatileness). Soon we divided $. 20 by fertile valley propagacià ³ n of. 03 and we obtain 6. 667 garrapatas volatileness. To continuacià ³ n, to reduce 6. 667 garrapatas volatileness of the volatileness of 36 and we have 29. 33 of volatileness for the commerce of difusià ³ n from $ 1. 00.& #13; También can determine the volatileness of propagacià ³ n like changes of prices of propagacià ³ n. We are going to fix the price of difusià ³ n from $ 1. 30. In order to calculate this, first we must have the value of propagacià ³ n ($ 1. 20 to 36 volatileness) and of finding the difference in dà ³ lares between éste and the new price of propagacià ³ n ($ 1. 30). The difference is of $. 10. This difference in dà ³ lares now is divided by the fertile valley of the differential. $. 10 divided by the difference. 03 fertile valley gives to a value of 3. 33 garrapatas volatileness him. Soon one adds the 3. 33 garrapatas to the volatileness of 36 and propagacià is obtained 39. 33 like the volatileness of the interchanges ³ n from $ 1. 30.& #13; Double-Go to verify our work by means of cÃlculo of the volatileness of the other manera.& #13; This time we are going to do cÃlculo moving the August 70 calls to the volatileness of the base of the June equality 70 calls. Según the calculated thing previously, the August 70 calls tendrÃa value of $ 3. 32 to 40 volatilidad.& #13; The June 70 two calls are worth dà ³ lares. 00 to 40 volatileness. AsÃ, the difference is a value of $ 1. 32 to 40 volatilidad.& #13; Now we are going to move the new price extendià ³ to $ 1. 30, $. 02 mÃlow s that the value of propagacià ³ n to 40 volatileness. Like before, we took the difference in the prices from propagacià ³ n. The result is $. 02 ($ 1. 32 – $ 1. 30). Then, it divides $. 02 by fertile valley ours expansià ³ n of. 03 (it remembers that the fertile valley of propagacià ³ n is equal to the difference between the fertile valley of the two individual options). $. 02 divided by. 03 give a value us of. 67. That. 67 the volatileness of our base of 40 is due to remain. That gives 39 us. 33 (40 -. 67) the volatileness of the interchanges propagacià ³ n from $ 1. 30. This volatileness responds ours cÃlculo previous to perfeccià ³ n.& #13; Perhaps at first sight, it is asked for qué we went to través of all these cÃlculos. With the June 70 calls to 40 volatileness, the two price of dà ³ lares. 00, fertile valley. 05 and 70 of August to the 36 calls of volatileness, the three price of dà ³ lares. 00, fertile valley. 08 Âby qué not to have an average of volatileness? This us darÃa a volatileness 38 for difusià ³ n with a price of $ 1. 00 when in fact $ 1. 00 in extensià ³ n represent 29. 33 volatilidad.& #13; This serÃa almost nine by garrapatas ones difference that represents a friolera error of 30%! Because, as it were said previously, Fertile valley is not linear, every month of way cannot be weighed uniforms and finishes both taking an average from months. By the love of argument to suppose it did that it. We say that you find the difference of fertile valleys of the options and came above for with one propagacià ³ n of the fertile valley. 03 that is the correct one. Nevertheless, when ³ n tries to calculate the volatileness of propagacià and the price that tendrÃan dificultades.& #13; Now, ³ n with the price of cotizacià returns to calculate propagacià ³ n of $ 1. 30, or $. 30 mÃhigh s that its value in 38 volatileness. It divides that $. 30 fertile valley differentiates superior in difusià ³ n from. 03. You obtain an increase of 10 by garrapatas volatileness. Añade that increases to base 38 volatileness. That means that you feel propagacià ³ n negotiates to 48 volatileness instead of 39. 33 volatileness! This type of error podrÃa to be very, very expensive. It remembers, apples with apples, oranges with oranges. It does not matter that volatileness opcià ³ n of propagacià ³ n to move the time as both options for a volatileness of the equality base.

Rum Ianieri is at the moment head strategist of options in the University of options, one compañ

Best Forex Practice Account – Do This Wrong and You Will Mess Up Your Trading

July 29, 2010 by  
Filed under Forex Trading

Best Forex Practice Account What if I said a forex practice account can be extremely damaging to your business life? If you’ve read any of my publications, you’ll know that I am a big fan of using fake money to play and practice software testing. However, if done incorrectly, wish it had never registered in one of these tools libres.Probablemente you are wondering why a forex practice account I cause any harm? It’s free. I can trade away all day and not lose a centavo.En First, if you’ve never heard of a practice account, is exactly what it sounds. It is identical to real trading account unless you have “play” money in it. You can test trading methods without risking your cash de.Muchos runners allowed to have one for free. Reason companies do this is just expect them to deposit money with them in a real account at some point in the futuro.Así here’s the problem. If you asked any full-time trader making it one of the biggest obstacles they often hear “emotions.” It’s amazing how emotional you can get when money is on the line. You are seeing prices rise and fall and his emotions go along with every tick of the price soon. Using fake money does not help get your emotions going. Best Practice Account ForexLa people tend to be very casual and careless openness to trade using fake money. They trade with large sums of money. If things go wrong, no big deal. You can even say that would not have done that if it was real money. Trust me on this, this happens all too frecuencia.Las emotions must be under control. Full-time, professional traders are very quiet, no matter if win or lose money. They know it’s just a game of numbers and losses are part of acuerdo.Creo in using these as a tool to help you become a better trader. It is a necessary step to take. However, it is necessary to treat it as real money. Get yourself into a mental state that money is real. Take it slow as you would with real money. Do not worry if you make losses. Do not get excited about winning trades. Follow your trading strategy to carta.Si you are using or planning to use automated trading software like me, use your forex practice account to test the software. Set up as instructed by the software company. Although not as critical of manual trading, be sure to configure and use it as you would with cash real.No mistake about it, use a Forex practice account the right way, and for software testing go a long way to a profitable forex trader! Best Forex Practice Account

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