Vega Question

Whenever I wanted to play a change in Vega in the past I have looked at the ATM options with a far off expiration.

But if someone wanted to profit from a a $1000 dollar investment in a change in the volatility (lets say an increase) would they be better off buying out-of-the-money options which they could buy many more of if the net Vega was higher?

E.g.

a) Buy $1000 worth of ATM option: Vega = 33 and price = 3.30
Net Vega = 100

or

b) Buy $1000 worth of OTM option: Vega = 3 and price = .10
Net Vega = 300


Seems like the higher net vega is a superior choice and the it may reduce some other risks as well...

Any thoughts?? It just seems counter-intuitive....

 

Have you considered other Greeks? What's your Theta in both positions?

 

The ATM have a Theta of .81
The OTM have a Theta of .146

Which makes sense the closer to the ATM the greater the Theta, right?

Lower Theta would be better if I am waiting for Volatility to move.

 

If I'm not mistaken you compare 3 ATM to 100 OTM, right?

So, in this case we have 3*0.81 vs. 100*0.146 or 2.43 vs. 14.6.
Sure, total Vega is higher on OTM, but so is Theta.

 

Yes, you are correct I forgot to think of Theta in "net" terms as well... It occured to me just after I hit post....

But if you didn't care about time decay and you just wanted to maximize profits from a changing volatility then would the Net Vega would be correct?

How would you weigh the vega vs theta?

 

I would just run some "what if" tests on both alternatives and see which one gives me the overall better risk/reward given various outcomes.

 

BTW... Thanks for your thoughts.... I always appreciate it when other take the time to help!

 

The net otm vegas will decline more rapidly over time as a function of being otm.

 

You really are going to have to run multiple tests with the different variables. I would recommend first determining what your forecast is. IOW, how much of an IV increase and when will it happen. That will determine your profit objective. After that you should analyze all the "what if" scenarios. Use this to determine you stop/adjustment point.

I wouldn't by any means forget about theta with this strategy, unless you are planning on the IV increase happening within a few days.

 

Thanks for the replies...

I was wondering if anyone had advice for running options though a Monte Carlo analysis. I now it is an open-ended question but I am new to the Monte Carlo tools. I realize it is different for non-linear items. Is there anything I have to include or exclude?