At the risk of sounding like my dad 40 years ago, I have to say I am not a huge fan of much of the music today, although I do like some of it. I listen to what is popular today with my kids mostly in the car. I noticed 2 main things. First, most of the rap sounds like angry adolescence trying to stick it to the man and wanting their voice to be heard. Ok we did that too – maybe with a little less attitude. Second, bands I grew up in the 70’s and 80’s actually created all their music on what we called musical instruments – like guitars and pianos. Today computers and electronics generate much of what we hear. Maybe the music industry is going the way of trading – computers replacing the old way of doing things.
Start with a pinch of delta. Add volatility. Shake. Greeks, and in this case delta, are critical in providing us with risk and performance information of our options positions. Problem is all greeks are static metrics. What that means they are snapshots in time, underlying price and volatility. Change one of these and delta (and all greeks) are affected. So let’s spend the next couple weeks looking at the impact of changes in implied volatility on the greeks.
Increasing volatility has an effect on delta of pushing all deltas toward 50. Let’s think about this intuitively for a minute. Assume vols are low right now. Really low. One definition of delta is the probability of the option finishing in the money at expiration. So in a low vol – low perceived risk environment options out of the money more likely to finish out of the money and options in the money more likely to finish in the money. That 10 delta option may become an 8 or 9 delta as the market expects the underlying to have little movement between now and expiration. Now imagine vols explode. VIX hits 80. Tremendous uncertainty in the market. If deltas represent probabilities of options finishing in the money then all deltas will move toward more uncertainty. The point of highest uncertainty is 50 delta. As vols increase the out of the money option deltas will creep up a bit as probability of those finishing in the money goes up a bit. Conversely, in the money option deltas may drop a bit since it is less certain those will finish in the money. These effects may be relatively small however if you trade fairly large size they can add up.