Short Vega: Bearish Delta Bias
Sep 14, 2017
Generally speaking, when the market goes down, volatility goes up.
The 2017 trading year provides an excellent example of this phenomenon, as the few times VIX has popped, that move has also been accompanied by a selloff in broader equity prices.
It's important that volatility traders are aware of this relationship because short premium strategies with a long delta bias are particularly exposed during a selloff.
Importantly, traders can manage their portfolios to alleviate this risk - namely by maintaining a bearish delta bias when holding significant short vega exposure.
If you'd like to review this topic in more detail, a recent episode of Options Jive is a great place to start.
On the show, the hosts walk viewers through an example that includes a range of outcomes when equity prices fall, and implied volatility rises. All the assumptions in the example remain static, except for the net delta bias.
Referring to that example, imagine a hypothetical portfolio with net vega exposure of negative 100. Now imagine that the related underlying price goes down $2, while implied volatility rises by 1 full point - certainly a plausible situation.
The chart below illustrates the P & L impact on the hypothetical portfolio given the above scenario. It also breaks down the results into three groups by tweaking the net delta of the portfolio (short delta, neutral delta, positive delta). As you’ll see, this example helps illustrate just how impacting overall delta bias (or lack thereof) is to a volatility portfolio:
As you can see in the slide above, when combined with a net long delta bias, the short premium (vega) strategy suffers when the market drops and volatility picks up. In this case, the net PnL is -$200, because the portfolio loses on both vega and delta (-$100 each).
Now compare this to the case in which the portfolio is short vega, but also net short delta against it. This time, the portfolio breaks even when the underlying price drops, and volatility rises.
It's very clear from this example that the net delta of a portfolio plays an important part in returns. It's therefore important to constantly monitor the net delta exposure of your portfolio to ensure it matches your ongoing outlook.
Depending on your own unique trading approach and risk profile, a directional bias (at times) may be the appropriate course of action. However, the risks associated with this decision should be fully accepted and understood prior to deployment.
As we can see in this example, mismanaging the delta component of a position (or overall strategy) can seriously impair the bottom line.
We hope you’ll take the time to review the entire episode of Options Jive focused on the “bearish delta bias” when your schedule allows.
This episode also highlights several other position structures that perform well with a short delta bias, in the event you are looking for new trading ideas.
We hope you’ll reach out with any questions or comments at email@example.com at your convenience.
Your feedback helps shape future tastytrade programming!
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.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastytrade is a trademark/servicemark owned by tastytrade.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).
tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.
Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.