If you've been reading my columns very long, you know that I like to look at my position Greeks to help me decide where the current risk in my portfolio lies. For those who are new to my Option Investor columns, vega is the risk that determines how much my position suffers when the volatility expands by 1 percent.
On March 9, I was looking at the vega of a 25-contract SPX APR iron condor, or rather the remainders of that iron condor. I'd used the rally to close out the bull put credit spread portion for $0.20, locking in my planned-for profit on that side.
With the SPX at $1,141.58 at the time, and my bear call credit spread at 1185/1195, the vega of that position was -437.57. A negative vega means that for each one percent that the volatility climbs, my position theoretically loses $437.57. Yikes! While I was very worried about the price risk if the SPX continued climbing, a worry that proved to be warranted, I wasn't worried about that high negative vega. Want to know why I wasn't concerned about that vega and why I wasn't doing anything to moderate that vega risk?
My original iron condor had consisted of the 1185/1195 bear call credit spread and the 930/920 bull put credit spread. If I hadn't bought back the bull put credit spread when it narrowed to $0.20 and locked in my profit on that position, the vega for the position would have been -146.12, much closer to the neutral level than the -437.57 that the position then displayed.
But did I realistically have a bigger volatility risk in this trade than I'd had before I'd closed that bull put credit spread? Would it have been better to have kept on that bull put credit spread just to neutralize that vega risk? There are certainly many ways of looking at the position, but in my eyes, closing out one side of the iron condor when the spread narrowed, thereby removing any possibility of risk should the SPX turn over in the 39 days then remaining until option expiration removed risk from the position, no matter what that vega number read.
Still, let's talk about the vega risk. Anyone who had watched the climb into March 9, when this article was roughed out, was either thrilled, appalled or just astounded, depending what one's position was. However, if you were also watching the volatility measures, you know that during times of strong rallies, volatility usually decreases. We sometimes have occasions when volatility rises during sharp rallies, as we have occasionally during this rally, but that's not the typical case, even this time. That strongly negative vega wasn't telling me that the position would benefit by a further climb, closer to my sold call. However, it was certainly telling me that the reduced volatility that tends to accompany such climbs, unless they're too extreme, would help offset some of the price risk.
Markets never rolled over, of course. However, what if the markets had rolled over and, as often happens in such cases, the volatility increased? That strongly negative vega was suggesting that my position would have suffered if that had happened.
In reality, how could I be hurt when prices rolled down and away from the only remaining part of the original iron condor I still held, the bear call credit spreads? As prices rolled away from the spread, I would eventually have been able to close it out and lock in profit. Now I'm just hoping it rolls over or stays away from my new rolled-into spread.
The take-away is this. Although I like to watch the Greeks and use them to help me think about risk, it's still necessary to put them in perspective. Unless volatility rises while prices are also rising--something that can happen but is probably rare--that negative vega wasn't going to hurt my position.