A lot of option traders don’t fully understand Option Greeks. The inexperienced option trader only focuses on the Greek known as Delta. Although Delta can tell us a lot about our option position, the best traders don’t stop there. A good trader will focus on volatility in the stock market.
When adjusting the Delta of an option position to manage risk, it’s important to understand how to use volatility to adjust a position in their favor, sadly many traders don’t. There are different types of adjustments that can be done to not only adjust the Delta on the trade, but also adjust the position’s sensitivity to the implied volatility of the underlying asset.
Picture this; say you’re in an option spread called a Butterfly, and the stock market trends up to hit your adjustment point. What kind of adjustment should you make?
Well, if you’re trading options, it’s important to follow the volatility chart as well as the price chart.
For example, if the underlying is trending up, that probably means the volatility is going down (but not always the case). So, when making your adjustment, wouldn’t it be better if you put on an adjustment that can benefit from a falling volatility? This is called a Negative Vega Adjustment. Unless you want to prepare for a whipsaw move in the market, then you can always do an adjustment that adds positive Vega to your position.
To help make decisions on what type of adjustments you want to make, learn some technical analysis skills. They can be really helpful! Learn to forecast both the price of the underlying and its implied volatility when you are studying the charts.
When making adjustments to your option trades, it’s always a good idea to keep Vega in mind. Ignoring this can seriously put a damper on your potential for long term returns.
To conclude, there are several ways to neutralize the Delta position of your option spreads. Always remember, when comparing your adjustment possibilities, analyze the volatility graph to choose the best Vega adjustment at the same time. Videos on this topic and others can be seen at www.sjoptions.com
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