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Jul 6, 2017

Research Specials: Vega of Low IV Strategies

By:Sage Anderson

Fans of tastytrade's internal research will want to keep their eyes peeled for a killer series featuring "a few good men" from this team on a newly developed show called Research Specials (Live).

If you haven't tuned in previously, you might consider starting with the episode entitled "Vega of Low IV Strategies," which provides a really interesting perspective on a very important topic.

During periods of depressed volatility, traders often consider strategies that take advantage of a potential reversion in volatility toward the historical average (i.e. higher). VIX has of course been hovering around 10 for most of 2017, while the average in VIX is closer to 19.

A recent blog post expanded on strategies that traders might consider when volatility is low, and we recommend reviewing that information if you haven't already. One key approach detailed in this piece is the time spread, or calendar spread.

Calendar spreads are executed by simultaneously purchasing an option with a longer-dated expiration month, while selling an option with the same strike in a shorter-dated expiration month. The short-dated sale effectively helps to reduce the cost of the premium that has been purchased in the out-month expiration.

Because we have deployed a position that is net long premium (i.e. debit spread), the calendar spread is characterized by long vega, and therefore benefits from an increase in implied volatility.

Ideally, the underlying will sit still, or move toward the strike price of the shorter-dated option until that leg has rolled off. After that, the owner of a calendar spread will be hoping that the underlying makes a big move up (in the case of a long call) or down (in the case of a long put), or that implied volatility increases.

For these reasons, deploying a calendar spread is ideal when one has a neutral (sideways) outlook for the underlying while the short is in play, coupled with a desire to be an owner of volatility over the longer term.

This episode of Research Specials (Live) does a great job of outlining the mechanics of a calendar spread while also presenting some important insights into the behavior of vega in these positions.

Vega is, of course, one of the "Greeks," which together make up a group of parameters that measure the sensitivity of an option's value to changes in certain market-related elements. Vega is the Greek that reports how much an option's price will change given a 1% change in implied volatility.

As you can see in the graphic below, longer-dated options have more vega than shorter-dated options (all else being equal):

The chart above clearly shows how options with more days-to-expiration (DTE) have higher vega and consequently are more sensitive to changes in implied volatility.

Along those same lines, it's also somewhat easy to see how the passing of time can have a big impact on long vega positions. If the underlying sits still, or implied volatility declines, traders owning these options will suffer.

To combat that decay, traders may decide to sell another short-dated option against their longer-dated options, once the original short-month option rolls off. This is, of course, prudent only if the trader expects neutral (sideways) movement in the underlying to continue.

Of course, the specific risk taken at any time is dictated by each trader’s unique risk profile, investment goals, and strategic approach.

We recommend watching the full episode of Research Specials (Live) focusing on the vega component of long calendar spreads when your schedule allows.

Additionally, we hope you'll tune into future episodes from this series as they are released.

If you have any comments, suggestions, or questions we welcome your feedback in the space below, or through a direct email to support@tastytrade.com.

We greatly appreciate your continuing involvement in the tastytrade community!

And as always, thanks for reading.


Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.


Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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