Option Volatility Trading : Strategies and Risk (Volcube Advanced Options Trading Guides) by Gleadall Simon

Author:Gleadall, Simon [Gleadall, Simon]
Language: eng
Format: epub, mobi
Publisher: Volcube
Published: 2013-11-24T23:00:00+00:00

For the classical case of a risk reversal whose put and call legs largely cancel each other out in terms of headline Greeks, a shift in the implied volatility curve will have less of an impact than a twist. Vomma, the change in vega for a change in implied volatility, is likely to be low since vomma is additive and the risk reversal will often see long vomma from the put offset by short vomma from the call. Naturally, if the risk reversal legs are less symmetrical, a long or short vomma position is still possible and vega may therefore still be altered by shifting implied volatility. Skew changes may still cause vega to alter, no matter how well spread the risk reversal. This is because skew changes can affect the two legs in different ways; for example put skew may steepen whilst call skew flattens or remains unchanged. In such cases, the net portfolio vomma of zero does not tell the whole story, since netting vomma across the portfolio only holds true for identical implied vol changes across the curve. Suppose a trader is long puts with 10 vomma and short calls with 10 vomma. His net portfolio vomma is zero and let’s assume his net vega is too. Suppose now that put skew steepens and call skew flattens. His net vega will have changed, despite his vomma of zero. The increase in put skew, raises his vega (since he is long vomma in the puts). The decrease in the call skew also raises his vega, since he is short vomma via the short call position and implied vol in the calls is falling; the change in implied volatility is negative and so is his vomma (in this part of the curve); the negative times the negative gives a positive change in vega. So this skew change leads to an increase in the overall vega.

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