At tastylive, vega and theta are extremely important concepts for our trades.
Being premium sellers, we are very interested in how changes in duration and volatility affect the prices of the options we sell. These metrics, captured by theta and vega respectively, can be related to each other using the theta/vega ratio.
The theta-vega ratio is calculated as theta divided by vega. This ratio allows us to determine how much theta we are collecting relative the amount of vega risk that we are taking on. The higher the ratio, the higher the amount of theta we obtain relative to vega risk, and the more optimal a scenario it becomes for selling premium.
To dig into this further, the research team looked at selling 1SD strangles in $SPY, $QQQ, and $GLD dating back to 2009. They sold these strangles with 45 and 75 days to expiration, calculating the initial theta to vega ratio.
They were able to demonstrate the relationship between implied volatility rank and theta/vega ratio, showing how high IV rank is associated with higher theta/vega ratios.
The study clarifies the risks associated with selling premium when IV is low because in these environments, a lower theta/vega ratio implies that the vega risk taken on for a short premium position, may be high relative to the theta decay .
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