Thursday, April 11, 2013

Estimating option volatility changes using ThinkOrSwim Analyzer

Today, I'd to continue to discuss the TOS analyzer, option volatility, Vega and $VIX. This is the 2nd post on this topic after the post yesterday which focused a little bit more on the discrepancy side.

To have a good understanding of the impact of volatility on high probability option portfolio, I need to be able to estimate how the option portfolio P&L changes when volatility changes, using the TOS analyzer (or some other option analysis software in the future).  In particular, the values of volatility of each strike are different. So how do we estimate the portfolio P&L changes if we use one IV value in the TOS analyzer?

On 4-3, I recorded the following IV vs Strike chart during market hour. It revealed a couple of relationships that I could understand at the moment:

Volatility skews

  • Put options have higher IV than call options
  • Front month IV changes fastest and further back month IV changes slower
  • Future month IV is visibly higher in the middle price range for put options only
  • As strike prices increase, the IV of both call and put options decreases.

The IV of calls and puts in the chart appeared to increase 0.3 if SPX declined 10 points(which might cause VIX to drop 1 point). It is a significant observation for me that if VIX drops 1 point the IV's of my portfolio options may drop 0.3 only. I'll focus the overestimation of P&L changes from Vega x IV  in one of my future post.
I also captured the IV vs Strike chart today (11 days after the above one) during market hour. This time, I noticed the VIX & RVX had discrepancies in the quote pane and the Analyzer as shown in the circled fields. These numbers matched pretty well in my previous image. Now the IV appears to make slower changes with the SPX prices in the chart below as time passes by. In theory, the IV/Vega should keep decreasing to 0 at expiration day.

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