BY: HANS ALBRECHT, CIM®, FCSI, VICE-PRESIDENT, PORTFOLIO MANAGER AND OPTIONS STRATEGIST, HORIZONS ETFS
January 30, 2018
File this one under ‘Lessons in option Greeks’.
Recently, WEED (Canopy Growth Corp.) has been moving around like a nervous Chihuahua in a room full of elephants. But in recent days, the volatility has suddenly slowed significantly. The implied volatility of the at-the-money February put has gone from 134 on January 16, to 83 on January 19, 2017. That is a significant drop in a short amount of time.
Remember that implied volatility is a relative measure of how much the equity is expected to move. On January 16, according to options pricing WEED stock was expected to move about 8.3% a day until expiry. On January 19, that expectation was down to 5.2% per day. With WEED at $38, the February at-the-money put (with a strike the same price as the stock) was $5.78 on January 16. On January 19, that put was $3.66 – with the stock at the same price.
If you had purchased that put, you would be out more than $2 and the stock hasn’t even moved! The Greek that measures the risk of a move in volatility is called Vega. Vega risk is actually much less with a shorter duration option like February, but nonetheless it was significant here. This is why I tell option traders to monitor where implied volatility levels lie within a range of one to two years. You want to have an idea of your Vega risk – and make sure you aren’t buying options priced much higher than usual, or selling options priced too low.
If you had been monitoring implied volatility levels in WEED options over the past weeks, you would have seen an unusually large and overdone rise in option pricing, which dramatically increased the vega risk in owning options. It’s not an exact science, but knowing your Greeks well can help with your option trading.
The views/opinions expressed herein may not necessarily be the views of 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.