Volga Vomma

Introduction

Volga or Vomma or Volatility Gamma is an option greek, a second-order derivative indicating the change in vega with respect to change in volatility.

 

Volga is positive for options which are not in-the-money and generally increase as the option gets deeper out-of-the-money. 

where,

V is vega

σ is volatility

 

A trader can use Vomma to measure the rate of change to Vega as implied volatility changes.

 

Let us understand Vomma with an example.

Let us assume you had an option with a value of $3.70 and a Vega of 10. This would mean that for every 1% increase in implied volatility, the option would rise by 10 cents.

 

Now, if an option has Vomma, it means that the Vega will change as the implied volatility changes.

If the option had a Vomma of 4, it means that when there is a 1% change in implied volatility, Vega will increase by 4.

 

Hence, if there was a 1% change in implied volatility, Vega would go from 10 to 14. The option's value would, therefore, likely increase by around 12 to $3.82.

 

For learning more about Volga in options trading, Try Free Preview of Course on Options Trading using Python. In the course, you can read the primer on Greeks for a better understanding.

 

Also, the Quantra course on Options Trading using Python can help you with more information regarding Options trading with Vomma.
 

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Volga Strategy
 

For a strategy with Volga, will check if the Volga percentile and Vega percentile are above 80. The timeframe for calculating the percentile will depend on the frequency of the data; for daily data, it can be 1 year. This means we will trade when Vega and Volga are on the higher side. 

 

If we predict that the volatility will increase, then we can deploy a long straddle as it would benefit from the increase in volatility. If we expect the volatility to decrease, we can deploy a short straddle.

 

Let’s say we have a view that the volatility will increase. We will deploy a long straddle in this case. We will spend a net premium when deploying a long straddle as we will buy both ATM call and ATM put options. 
 

We will keep the stop-loss at 60% of the net spent premium and the take-profit can be kept at 140% of the net premium spent. For example: if the net premium spent is 100 points. We will keep the SL at 60 points and TP at 140 points.

 

The entry and exit conditions will be:

• Entry: vega_percentile >= 80 & volga_percentile >= 80
• Exit: net_premium > take_profit OR net_premium < stop_loss OR days_to_expiry == 0

 

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FAQs

1. Which option type to consider American or European?
Answer - We can deploy this strategy on both European and American options provided that we have a proper pricing engine to calculate the greeks and Implied Volatility (IVs) of the options.
 

2. Why are we deploying the strategy above the 80 percentile of Vega and Volga?
Answer - We will deploy this strategy at high Vega and Volga values as implies a higher rate of change of the option's value (premium) with every percentage change in volatility. The figure of the 80 percentile is just for reference. You can change this as per your view.