Papale on VIX and Greeks

Normally I try to insert some “pseudo wit” in the first line or two but today I simply want to offer up my thoughts and prayers to the victims and people of Boston.   On Monday when the news came across my desk I turned on the TV and immediately recognized the area that was the target of the explosion.   You see,  4 years ago I was standing just about where the bomb went off rooting for my wife, Marilee to finish the 2008 Boston Marathon.  In fact her time was just a bit over the time that was on the race clock at the explosion of 4:09.  May God be with us all.

 It seems traders and investors have found the sell button on their computers in the last week or so.  Markets have been on a bit of a rollercoaster ride lately but overall we have been more decidedly to the downside.  On Monday with markets already down and events unfolding in Boston, the VIX spiked 5 pts or more than 40%.  This dramatic change in implied volatility (IV) can significantly affect the risk profile of option positions.  For example, such a large increase in IV causes out of the money option deltas to increase.  This reflects a higher probability of those options finishing in the money.  More perceived movement in the underlying – the greater the chance the market could reach all option strikes.  The higher IV equates into a lowering of gamma around the at the money strike.  More of these options will gravitate toward 50 so there will be less delta change for those strikes as the market moves.  Out of the money and in the money options’ gamma may increase as these option deltas are slightly more responsive to movement in the underlying in the higher IV environment.  Higher IV means higher theta as all options have a greater extrinsic value and hence more to decay.  Bottom line – pay a little more attention to your greeks these days.  Your risk may not be what you think.

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