Option expiration term and IV change risk

M

MrAgi1

I understand how IV varies across expiration and all that(volatility term structure). Also longer term expirations have larger vega than shorter term.

It appears despite having smaller Vega, short term options are exposed to greater risk due to change in implied volatility. Is that true and why? Is Vega useless and just large for no apparent reason in longer dated options?


If there is a sudden unplanned news(unlike earnings) such as a pandemic, natural disaster, political election, major coup e.t.c which option expiration would experience more IV spike(increase in IV); longer or shorter term? And why?

For less serious situations like earnings, market gaps and other none obvious(not extreme) reason for increased market volatility; which expiration term experience significantly more change in IV? And why?


So my short LEAP straddles is better of in times of great uncertainty than short straddle expiring at the end of the week(that I just put on)? Sounds counterintuitive.
 
It seems you got bamboozled by option theory.

1. Vol of vol is larger in shorter maturities but vega is smaller -> 10vols in a 5 dte option are merely a couple of cents vs. the dollars of P/L you are exposed to a 10vol move in LEAPS

2. realized volatility is an average of the time period you're looking at. A 5 day moving average is more volatile than a 365 day moving average

3. For those reasons comparing 30day vol and 90day vol is apples to oranges and should not be done. You trade each vega bucket individually or use a weighted vega if you trade calendars.

4. The risk of short term options is not vega but gamma, since gamma per vega is much higher short term than for leaps. You can easily sell 50 LEAPS and delta hedge because their gamma is tiny. Selling 50 same day options is a pure gamma play and will most likely blow you out of the water because gama is insanely huge. On the other hand you have huge vega risk in the LEAPS.

In the end, it all comes down to what is mispriced. If you think LEAPS are cheap and you buy them, you are trading vega. If you think 20 dte options are expensive and you sell them you are trading gamma vs realized or terminal distribution.
 
That vega for longer DTE is higher than for shorter DTE is IMO logical.
It's analog to the case where the spot range (vertically from -1SD to +1SD around the mean) for a longer DTE is higher than for a shorter DTE.
Best seen when inspecting the visualization of GBM (the x-axis (horizontal axis) is the time axis):
loop_sim-1.png
 
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MrAgi1 said:
Also longer term expirations have larger vega than shorter term.

It appears despite having smaller Vega, short term options are exposed to greater risk due to change in implied volatility. Is that true and why? Is Vega useless and just large for no apparent reason in longer dated options?

So my short LEAP straddles is better of in times of great uncertainty than short straddle expiring at the end of the week(that I just put on)? Sounds counterintuitive.
More...
Hmm. I think there is some mathematical misunderstanding here.
The longer the timeframe the bigger can the range of the variability (the absolute price range for -1SD to +1SD) can become.
Accordingly a bigger value of vega for a bigger DTE.

In practice it indeed looks counterintuitive when the premium of shorter DTE option moves faster (especially when seen as % chg) than that of the longer DTE option. But this is explained by the famous options time decay curve: :)

Decay.jpg
 
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MrAgi1 said:
If there is a sudden unplanned news(unlike earnings) such as a pandemic, natural disaster, political election, major coup e.t.c which option expiration would experience more IV spike(increase in IV); longer or shorter term? And why?

For less serious situations like earnings, market gaps and other none obvious(not extreme) reason for increased market volatility; which expiration term experience significantly more change in IV? And why?
More...
In both cases the IV of the shorter DTE should be higher than the expected IV of the far remote DTE of the future, b/c nearer events can usually be better predicted (forecast) than events much in the future. The effect of an actual event happening right now usually can be better concluded than the outcome of a future event...

If two similar events will happen at T and T+x, then at T the IV will be higher than the IV of the future T+x (at the time of T).
And at T+x the IV will then be high as well like it was at T.
 
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In summary: Assume right now I buy a put expiring in 1 month and simultaneously purchase another put expiring in 3 years times. If there is a massive global pandemic breakout in the next 1 week, my 1 month option would gain more value due to IV exploding much more? Or no?

@earth_imperator
@MrMuppet
 
MrAgi1 said:
In summary: Assume right now I buy a put expiring in 1 month and simultaneously purchase another put expiring in 3 years times. If there is a massive global pandemic breakout in the next 1 week, my 1 month option would gain more value due to IV exploding much more?
More...
Depends on the company: if it's a biotech company then such an otherwise negative event can be beneficial for such a company, ie. the stock price can rise.

IVs of both of the long put options will rise, the IV of the one with shorter DTE will rise more. Both will gain value from IV rise.
But of course also the stock price will be impacted. If we assume that such an event has a negative impact on the underlying stock price, then for long puts this is of course an ideal situation (IV rises and stock falls).
Yes, the one with the shorter DTE will gain more (at least percent-wise PnL).
But, IMO you better should close the one with the shorter DTE "immediately or very soon" b/c its value is eroding fast due to the time decay curve (ie. a long option each day loses value... like ice melting under sunlight...)

You can simulate these cases with optioncreator etc. :
30d: https://optioncreator.com/st0b50w
3y: https://optioncreator.com/sthghb4

For example if after 5 days the IV rises to 150 (from 30) and stock falls to 80 (from 100), then:
1) PnL = 22.73 / 3.43 * 100 = 662.68%
2) PnL = 62.10 / 20.49 * 100 = 303.07%
The first one is the one with the shorter DTE.
Ie. The PnL is much higher: 662% vs. 303%
(For simplicity the IV rise is the same in both cases, but in reality the IV rise of the first one will be higher than for the other one, for example 225 to 150.)
 
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earth_imperator said:
Depends on the company: if it's a biotech company then such an otherwise negative event can be beneficial for such a company, ie. the stock price can rise.

IVs of both of the long put options will rise, the IV of the one with shorter DTE will rise more. Both will gain value from IV rise.
But of course also the stock price will be impacted. If we assume that such an event has a negative impact on the underlying stock price, then for long puts this is of course an ideal situation (IV rises and stock falls).
Yes, the one with the shorter DTE will gain more (at least percent-wise PnL).
But, IMO you better should close the one with the shorter DTE "immediately or very soon" b/c its value is eroding fast due to the time decay curve (ie. a long option each day loses value... like ice melting under sunlight...)
More...
Well explained got it. :D
 
Dont you have an option pricing calculator??

Play around with OptionStrat..Free version is helpful

Dont play around with EI..Not helpful


MrAgi1 said:
In summary: Assume right now I buy a put expiring in 1 month and simultaneously purchase another put expiring in 3 years times. If there is a massive global pandemic breakout in the next 1 week, my 1 month option would gain more value due to IV exploding much more? Or no?

@earth_imperator
@MrMuppet
More...
 
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