When you are long vega, like owning calls or buying time spreads, and you have positive vega, what is more important...IV increasing or HV increasing? All things being equal, what will happen if IV decreases and HV increases? Does vega relate to the amount by which IV changes 1%, or realized vol changes 1%?
My understanding is this - yes if you are long vega you are sensitive to a change in IV and are looking for a change in implied (to your point though generally IV/RV tend to move together). For example if you bought a straddle and the only variable that changed was an increase in IV you would benefit (even if the underlying didn't move at all). If you are looking to benefit from changes in realized volatility, you would focus on your gamma exposure. Which effect dominates will depend on your vega/gamma position.
Greater chance to trade away from the strike if you get a rise in HV. ideally you want a rise in IV and a drop in HV, but obviously they're usually mutually exclusive. There is a lot of moving parts when you're discussing index positions. I've seen a lot of guys get hurt being long vol in index and flipping modality on delta. Now they're holding bull positions and the strike is underwater on skew. Vega relates to IV. Cals with short duration are very sensitive to gamma. You can see an substantial rise in IV but lose as spot diverges from your strike. If you can predict price, trade verticals. If you can predict vol, trade calendars.
(a) The general wisdom is that a calendar, if done root-time vega flat, is a short risk product. Meaning that if vol picks up, you are most probably going to lose money. (b) A corollary to that is that most money is made on the on the lack of realization in the front and the forward volatility that you are purchasing is a sort of weak protection (c) Your worst case scenario is obviously a relief rally - market rallies violently (you take a beating on your short gamma position) and the overall level of vols comes down (so, your vega does not feel nice either)
just so my understanding is right... vega neutral is the same as root time vega flat? am i right at least in one of these respectively thinking that you create your ratio with legs in a calender untill your vega is equalized or as you put it "flat" typically the fronts have higher implied values then backs... so you would buy more backs relative to fronts to "flatten" the vega.. wouldn't this position constantly need adjustment? or no.. for otm's you get a spreadening of implied values approaching expiration.. meaning the front gets a higher implied number at a faster rate then the back does..
You have to determine the weighted vega for your position, just don't add up vega's for each leg. Details for calendar lie in weighted vega, you actually might be short vega on a calendar after adjusting the weighting. Be careful about it. If you believe front month IV will implode faster than back month, that should be your edge in calendar. You are short gamma in a calendar so you ideally want front month to implode more than back month and you want realized vol to go down ( meaning not much movement in underlying). Hope it helps you gain more understanding of calendars
No, root-time vega flat is the same thing as notional-flat for ATM options. In general, you will find that implied volatility moves in manner that is inversely proportional to root of time to expiration. E.g. if 1 year implied moves 1 vol, 3 month will move 2 vols. Usually, when people talk about being "flat weighted vega" they mean zero root-time vega brought down to some common tenor. As I said, however, at least in the index space, most of your money in a calendar would be made from being short gamma (you might be lucky and catch a curve steepning, of course) on a high implied, since in the time of crisis IV/RV premium is usually pretty high. Also, you have a variety of risks that are going to make the position pretty random. For example, your position is in fixed strike options, so you can find that even though volatility has increased, your residual vega is small.
hi Atticus and all, If trader can predict drift from ATM strike by 1.5-2 sigmas inside of 10 days what spread would you suggest IF the expiration of front month is 10 days away? I was initially leaning towards short ATM calendar-xyz at 50, short mar50c long apr 50c if expiration > 10 days BUT inside of 10 days front vega /theta implosion is just too big to overcome. Any suggestions? short fly in month 2 perhaps? THANKS.
I meant short cdr by bring long mar and short apr ATM strike to take advantage of drift away from 50. Thanks