Unfortunately, many traders are not option strategy "instrument rated"; that is, they do not know how to read the Greeks when trading. When any strategy is constructed, there are associated Delta, Vega and Theta positions, as well as other position Greeks. If you open any basic options book for beginners, you'll typically find a calendar spread as an off-the-shelf, plain vanilla approach.
The CRB was designed to isolate and reveal the directional movement of prices in overall commodity trades.
A seagull option is structured through the purchase of a call spread and the sale of a put option (or vice versa).
This structure is appropriate when volatility is high but expected to fall, and the price is expected to trade with a lack of certainty on direction.In the second example above, a hedger purchases a seagull option structured as the purchase of a call spread (two calls), financed by the sale of one out-of-the-money put, ideally to create a zero-premium structure.
When options are traded outright, or are combined, we can calculate position Greeks (or net Greeks value) so that we can know how much risk and potential reward resides in the strategy, whether it is a long put or call, or a complex strategy like a strangle, butterfly spread or ratio spread, among many others.
If you have a neutral outlook on a stock or futures market, the calendar spread can be a good choice for strategists. This is one of the reasons that the CRB is so closely watched by both bond and commodity traders.
This tutorial is aimed at getting you instrument rated in options trading, to continue the analogy with piloting, so that you can handle any strategy scenario and take the appropriate action to avoid losses or enhance gains. That is why knowing what the Greeks are telling you is so important.Greeks can be incorporated into strategy design at a precise level using mathematical modeling and sophisticated software.
If you sell an at-the-money front month option and buy an at-the-money back month option (standard calendar spread), the Vega values on these options will net out a positive position Vega (long volatility).That means that if implied volatility falls, you will experience a loss, assuming other things remain the same.
A seller of that option, on the other hand, faces risk with a wrong-way price move in the opposite direction or a rise in IV, but not from time value decay.
But at a more basic level, the Greeks can be used as guideposts for where the risks and rewards can generally be found. A simple example will help to demonstrate how not knowing the Greeks can lead to making bad choices when establishing options positions.
In the next part of this tutorial, the role interest rates play in option valuation will be touched on in order to complete the overview of the Greeks.
Likewise, watching Vega and other Greeks can help keep options strategists from suffering a sudden dive in equity resulting from not knowing where they are in relation to the risk horizons in options trading - a dive that they may not be able to pull out of before it is too late.
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