Volatility-Sensitive Options are options contracts whose market prices exhibit a significant and direct correlation with changes in the underlying asset’s implied or realized volatility. Their valuation is particularly influenced by shifts in market expectations regarding the magnitude of future price fluctuations. These options are crucial for strategies focusing on market turbulence.
Mechanism
The sensitivity of an option’s price to volatility is primarily quantified by Vega, one of the Greek parameters, which measures the change in option price for every one-point move in implied volatility. Options with longer times to expiry and those positioned at-the-money generally possess higher Vega values, making them more sensitive to volatility changes.
Methodology
Traders utilize volatility-sensitive options, such as long straddles or strangles, to speculate on anticipated changes in market volatility rather than on the underlying asset’s directional price movements. This involves careful monitoring of both implied and historical volatility, employing strategies designed to profit from an expected increase or decrease in market turbulence, while actively managing other associated Greek risks.
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