BY: HANS ALBRECHT, CIM®, FCSI, VICE-PRESIDENT, PORTFOLIO MANAGER AND OPTIONS STRATEGIST, HORIZONS ETFS
May 31, 2017
When we talk about risks in option trading, the ‘Option Greeks’ can help us to navigate the effects that a number of variables can have on our performance.
Gamma, for example, explains how quickly a short option position is likely to hurt when the underlying instrument is moving against us. Vega illustrates how a one-point move in implied volatility will affect profit/loss. When option pricing is low, particularly in options that expire at least six months from now, I like to utilize a strategy called ‘Making vega your friend’. When looking for broader protection for my portfolio, I always try to be cognizant that buying longer-term options requires that greater attention be paid to Vega, as its impact gets more pronounced the longer the duration of the option. Buying a one-year option at a relatively high implied volatility (i.e. at the higher end of its recent two-year range), could expose an investor to the potential for losses due to a drop in relative option pricing in that contract.
The good news right now is that one-year implied volatility for 15% out-of-the money puts in the SPX is sitting at 10-year lows! This makes protecting a portfolio as cheap as it has been in many years. You can expect to pay approximately 2.1% annualized to buy a one-year put with a strike that is 15% out-of-the-money. Buying protection right now may make a lot of sense: it could help you to stay the course and remain invested in equities. If stocks sell off, vega will become ‘your friend’, as implied volatility could return to higher levels.
These markets have run ahead strongly, but should they correct, it’s good to know you’ve got cheap insurance.
Source: Bloomberg, between May 9, 2007 and May 9, 2017.
The views/opinions expressed herein may not necessarily be the views of AlphaPro Management Inc. and Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.