The majority of options investors, no matter what level of experience they may have, do not assess the market value of an option before taking a position. This occurrence is especially interesting due to the fact that these educated investors would not approach any other asset purchase without first researching their fair market value.
Market psychology seems to be to blame for this phenomenon, as traders believe that an option can skyrocket in value if the underlying security make the predicted move. This can cloud the judgment of the investor, and lead to costly errors.
Haste and greed all too often play a roll in careless assessments by investors, as the predicted event may already be priced into the option. This could result in a decline in the option’s value when the expected move is finally made.
The secret of options pricing can be revealed by looking at implied volatility. By understanding the roll of implied volatility, you can position yourself to better take advantage of it in the market.
Volatility is the measure of the pace and size of the change in price of an underlying security, and is an indispensable factor in deciding the level of option prices. If there is high volatility, the option’s premium will be comparatively high, and if the volatility is low, the premium will also be comparatively low.
As implied volatility levels change, so do your strategies. Every strategy for trading options has an related Greek value known as Vega. When implied volatility rises, positive Vega strategies such as strangles/straddles, backspreads, and long puts, work best. When implied volatility is falling, negative Vega strategies such as short strangles/straddles, ratio spreads, and short options work best.
Knowing where implied volatility levels are currently are where they are liable to go once you are in a trade can greatly affect the results of your strategy. It is advised that you familiarize yourself with the fundamentals of Vega and how to interpret it before you can utilize it effectively.
Options Volatility And Strategy
Inexperienced traders often overlook volatility when establishing an option position. This can be attributed to a lack of understanding. It is important to understand the concept of Vega to fully understand the relationship of volatility to the majority of options strategies.
Vega is a measure of the sensitivity of an options price to changes in volatility, much like Delta is a measure of the sensitivity of an option to fluctuations in the underlying price. Both of these can be working at the same time, and they can have a combined impact that either works in concert or counter to each other.
When establishing an options position, both a Vega and a Delta assessment is required in order to fully understand what you may be getting into.
Volatility fluctuations can have an impact – bad or good – on any options trade you are preparing to employ. By fully understanding these effects, and how it dictates strategy, you can profit in any market.