It has been about a month or so since I last touched on the topic of Implied Volatility. Last week we talked about credit spreads, and today I am in the mood to merge the two topics together. I have heard many traders say that they pick a trade based on the implied volatility of the underlying. Touché. At the same time I hear others try to generalize strategies saying that if Implied Volatility is high (options are expensive) then you want to be an option seller (credit spreads). If Implied Volatility is low (options are cheap) then you want to be a buyer (debit spreads). Let's go through an example. Assume I was going to sell a bull put spread on Apple Computers: AAPL. Let's really examine this trade closely. Keep in mind Apple was at 91.00 at the time of this post.

AAPL DEC 85 PUT ASK .65 D -.16 G .04 T .04 V .05 IV 32.72%

AAPL DEC 90 PUT BID 2.00 D .43 G -.06 T .06 V -.08 IV 31.55%

Both of these options are out-the-money. No intrinsic value involved here, which makes these premiums 100% time value. Assume we have successfully sold this spread, and we are short this position. Let's look at it as a whole....

AAPL DEC 85/90 Vertical CR 1.35 D .25 G -.02 T .10 V -.03 IV 32.13%

This might be confusing, but I am giving you the net position from the offsetting greeks (D=Delta G= Gamma T=Theta V= Vega IV= Implied Volatility). For example the negative delta on the long put offset by the positive delta on the short put equals a small, but positive delta position. Almost the equivalent sensitivity of an OTM option. You are also in a negative gamma position, since you are short a higher gamma than you have purchased. You are long theta, which is the most important piece of this trade. Now going back to my correlation with Implied Volatility...the reason the new IV is different is because I am using the average implied volatility of the two strikes. Notice how we have a neutral/negative vega though! For every 1% increase in IV...we lose three cents. Hardly sensitive to change in volatility right! You can take over priced or under priced options and typically they offset the impact of implied volatility. Going back to the foundation of this trade, you are not sensitive to IV since you have bought an expensive/cheap option and you've sold one as well.

I hope this sheds light, rather than casts a shadow. If you have questions I will montior the chat. Throw some chatter out there.