When purchasing a time spread, the investor should pay attention
not only to the movement of the commodity options trading price
but especially to the movement of volatility.
Volatility plays a very large roll in the price of a time spread
and, as we have stated, the time spread is an excellent way
to take advantage of anticipated volatility movements in a hedged
Since the time spread is composed of two options, the investor
should understand the role of volatility in commodity options
trading as well as in time spreads. Lets start with commodity
options trading volatility.
A commodity options trading volatility component is measured
by a term called vega. Vega, one of the components of the pricing
model, measures how much a commodity options trading
change with a one point (or tick) change in implied volatility.
Based on present data, the pricing model assigns the vega for
each option at different strikes, different months and different
commodity options trading prices.
Vega is always given in dollars per one tick volatility change.
If an option from your commodity options trading is worth $1.00
at a 35 implied volatility and it has a .05 vega, then the option
will be worth $1.05 if implied volatility were to increase to
36 (up one tick) and $.95 if the implied volatility were to
decrease to 34 (down one tick). Remember, vega is given in dollars
per one tick volatility change.
As we continue to discuss vega, keep these facts in mind:
- Vega measures how much a commodity options trading price
will change as volatility changes.
- Vega increases as you look at future months and decreases
as you approach expiration.
- Vega is highest in the at the money commodity options trading.
- Vega is a strike-based number it applies whether the strike
is a call or a put.
- Vega increases as volatility increases and decreases as volatility
It is important to note that a commodity options trading volatility
sensitivity increases with more time to expiration. That is,
further out-month commodity options trading have higher vegas
than the vegas of the near term options. The further out you
go over time, the higher the vegas become.
Although increasing, they do not progress in a linear manner.
When you check the same strike price out over future months
you will notice that vega values increase as you move out over
The at-the-money strike in any month will have the highest vega.
As you move away from the at-the-money strike, in either direction,
the vega values decrease and continue to decrease the further
away you get from the at-the-money strike.
Remember, vega (an options volatility component value) is highest
in at-the-money, out-month commodity options trading. Vega decreases
the closer you get to expiration and the further away you move
from the at-the-money strike. The chart below shows vega values
for QCOM commodity options trading.
As you look at the chart observe the important elements: the
commodity options trading
price is constant at 68.5; volatility
is constant at 40; time progresses from June to January; and
finally, the strike price changes from 50 through 80. Notice
the increasing pattern as you go out over time. Also notice
how the value decreases as you move away from the at-the-money