July 31, 2019

How the Greeks Work Together (Or Don’t)

We are looking at a theoretical example in Micron (MU).  Let’s assume that MU will report earnings next week after the market closes on August 5th.  Even though Implied Volatility is currently extremely expensive, it most certainly will move higher as we approach earnings.

So, a thought process might be, why not buy volatility now if it’s going to move higher by next week? We first must understand what changes an option price as volatility moves. That “Greek” is known as Vega.  Vega measures the change in the value of an option with a 1% change in Implied Volatility.

For example, if the Implied Volatility of the MU September 21st expiration, 42 strike call is 74.29, which can be seen below, and its VEGA component is 2.62, then the value of this option will change by $.0262 when the implied volatility changes by 1%.

So if the implied volatility rises by 6 points to 80.29, then the value of the option will rise by $.1572,  (6 x $.0262). Conversely, if the implied volatility decreases by 10 points to 64.29, then the value of the option will decrease by $.262, (-10 x $.0262).

Again, if we believe that implied volatility is going to rise by next week, we should buy it now, right?  Not so fast. This is where one of those other “GREEK’s” comes into play. Theta measures the amount of premium or time decay that decreases the price of an option daily.  The THETA of this option is $.11, which means that this option will lose $.11 daily due to time decay. One additional characteristic of THETA is that it is not linear, meaning that an option does not decay the same amount each day.  It actually increases by a greater amount the closer to expiration it becomes. But, for example purposes, let’s say that the September 21st, 42 strike call did decrease by $.11/day due to theta.  Then looking ahead the earnings report after the market close on September 20th, that would be 8 days of premium decay or a decrease in the value of this option by $.88, (8 x $.11).

As you can clearly see, the price decrease due to theta decay can far outweigh the projected rise in implied volatility that we expect to see leading up to earnings.

 

about the author:

Scott Bauer

A respected market commentator seen on Bloomberg, Fox Business, CNBC and other major financial networks, Scott Bauer has 25 plus years of professional equity and index options experience at the Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange (CME) and as a Vice-President/trader for Goldman Sachs. Scott graduated with Honors from the University of Illinois Business School and has taught classes both at his alma mater and at the CBOE.

Read Similar Articles

August 4, 2020

TSLA Inside Bar Entry

An inside bar is just what the name implied.  It is a bar that is “inside” of another bar.  We use a daily chart for this approach.  So the high from two days ago is higher than the high from one day ago and the low of two days ago is lower than the low […]

Read Article
August 3, 2020

Option Ratio and Backspreads

  A ratio spread is a neutral options strategy in which an investor simultaneously holds an unequal number of long and short or written options. … Conceptually, this is similar to a spread strategy in that there are short and long positions of the same options type (put or call) on the same underlying asset.   A backspread is s a type of option trading plan in which […]

Read Article
July 29, 2020

Is JPM Morgan Poised For Its Next Leg Up?

  We believe that some banks are in a position to make the next leg up?  Why? You ask.  Unlike your conventional banks, some banks like Goldman Sachs, JP Morgan, Citibank and, Morgan Stanley have resources that many conventional banks do not.  They have MASSIVE trading entities.  They are not simply a place to park […]

Read Article

Read Similar Articles

September 30, 2020

Bad News For NKLA Can Be Good News For NIO

  We had a great example of a swing buy entry in NIO, Inc., the electric car company (Ticker: NIO). It’s based on a break out pattern on an hourly chart and confirmed with a daily chart.   Click the video below to learn more details: Grab a free day pass to one of our live […]

Read Article
September 29, 2020

The Similarities and Differences Between VIX and VXX

The VIX and VXX are both very popular trading vehicles for trading volatility.  But, unlike the perceptions of many traders, they are not exactly interchangeable.  There are many similarities and more importantly, some very important differences. Click the video below to learn more details: Grab a free day pass to one of our live signal […]

Read Article
August 4, 2020

TSLA Inside Bar Entry

An inside bar is just what the name implied.  It is a bar that is “inside” of another bar.  We use a daily chart for this approach.  So the high from two days ago is higher than the high from one day ago and the low of two days ago is lower than the low […]

Read Article