No matter if you are trading stock options looking for a big earning’s surprise like Netflix (NFLX) or believe there is disappointment in the corporate filings as with McDonalds (MCD), the two most important factors are gamma and vega.
OPTIONS 101
Gamma is directly linked to the move the underlying experiences. In order to identify a trade, no matter what stock I’m following or what my earnings expectations are, I see what the market is pricing into the move via option prices and then construct a trade that can withstand this move.
DON’T MAKE THIS MISTAKE
But what even seasoned traders sometimes neglect is vega.
Vega is an option’s sensitivity to a change in implied volatility. We “know” with a great degree of confidence that implied volatility will regress to the mean nearly immediately after the report is released.
BOTTOM LINE
It is paramount that you identify and manage a trade’s vega exposure. Your ability to properly model to what level the implied volatility will regress to will greatly determine your consistence and degree of profitability.
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