Forex Options TRADING VOLATILITY: VEGA, Implied Volatility and Spreads - Singapore Forex Trading, Singapore Forex Academy, Singapore Forex Association

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Forex Options TRADING VOLATILITY: VEGA, Implied Volatility and Spreads

Option traders in general have looked at volatility as tradable itself. It can and should, in fact, be treated as an asset class and traded. 

The trader needs to ask the question: Is volatility high or low? Is it at an extreme? Is it expected to increase or decrease? 

Once these questions are answered, the trader can choose to benefit from increased volatility by buying straddles or strangles or selling straddles or strangles when volatility is expected to come down.

Volatility plays can coincide with fundamental events. 
For example, an upcoming election in a country will be accompanied by increased uncertainty and therefore increased volatility. 
A world crisis leading to an expectation of war will increase volatility. 

There are many option volatility strategies. 
Generally, if vega is net positive in a spread combination, the trader wants volatility to rise. 
If the net vega is negative, you want to see volatility fall. A favorite strategy for trading volatility involves spreads. 

Calendar spreads, call ratios, and put backspreads are used. Call ratios are used to sell volatility (negative vega). Put backspreads are a strategy used to buy volatility (positive vega). Calendar spreads are a very effective way to trade volatility. 

Implied Volatility and Spreads

The forex option trader should try to match the implied volatility conditions to an option strategy. 

Straddles and strangles are popular strategies for anticipated low-volatility conditions. Selling straddles and strangles is popular for high-volatility conditions.

GAMMA SPREAD TRADING

In gamma trading the ideal scenario is when the markets are very nervous. A high gamma means that there will be a high delta and therefore frequent moves. 

This is not uncommon in forex. In constructing spreads, a combination resulting in a positive gamma benefits the trader if the underlying moves very quickly up or down.

When a spread combination is negative gamma, the trader wants the underlying to move slowly up or down. 

The trader should also look for implied volatility conditions. If implied volatility is below historical, there is a chance that the market is about to move violently, and therefore the trader would look to go long gamma. 

In a declining gamma situation, where there is expected declining volatility, a calendar spread where one buys an ATM call and sells a same strike further out would be a potential play.