The Greeks and Their Mystery Unveiled! - Part 13

Welcome to part 13 of my series on the Greeks. In last weeks article we started looking at managing the Greeks on the level of the whole portfolio, rather than just in individual trades. We will do this by assessing some trades on the SPY (S&P500), AAPL (Apple Computers) and GOOG (Google). We will use real Greek values in the study, but for simplicity will round each one to the nearest whole number.

By now we should know that when managing the Greeks, we have to actively decide how much exposure to each Greek we want. We also need to decide what sign we want to have in front of our Greeks: Do we want positive or negative Gamma / Theta? Where do we think IV is going, so do we want positive or negative Vega? Do we want to be neutral in any of our Greeks? Do we understand the tradeoffs because we know we can’t have all 4 Greeks working in our favour.

With end of day data from April 6th 2009, we are going to use the scenario that we were bullish on the SPY and we thought IV was low, and could go higher.

Already we can see that we have a lot of positive Deltas in our portfolio, and as they’re all in the SPY, we can safely say that if the market goes up we’re going to make a lot of money and if the market goes down, we’re going to lose.

We want to place trades on AAPL and GOOG as well and therefore need to take a view on each asset. Let me emphasise the following ideas are not my views on the stocks. I will be actually giving false and sample views just to create an example of considering portfolio Greeks when constructing trades.

For the next example, I will be bearish on AAPL, and conclude that IV is extremely high. Given my IV assumption, I would want to create a trade with negative Vega. The way I can gain this is by selling some OTM Call Spreads. Naturally I need to consider the max risk I'm prepared to put into the trade when deciding contract amounts but at the same time I'm going to consider how the trade affects my overall Greeks.

Now for GOOG: My sample view for Google is that it is range bound and IV is extremely low. I know from my decision to have a range bound trade that I will be wanting a low Delta, negative Gamma and consequently a positive Theta, but what Vega sign do I want? As my sample view is that IV on Google will increase if anything, I will want positive Vega. The range bound trade I will select will be a Calendar Spread as opposed to a Butterfly simply for the reason that At The Money, a Calendar has positive Vega, whereas a Butterfly has negative.

Let’s now take a look at the over all Greeks for the Portfolio.

Have a good look at the Greeks here. Decide if in this hypothetical example we have too much or too little exposure to any one. Remember to consider how they will change over time too. In part 14 we will study this some more.

Manage your Portfolio Greeks!

Matt Baker