Thread by @muskk

(A little thread)
#PnlExplain
Whatever options position one enters it's important to know the risks one is taking and hence where the PnL is coming from. As an example if one is taking delta-neutral strangles (say 2% away OTMs on Nifty weeklies) at market open on a Friday and
+

within a couple of hours sees a 5pt reduction in the price of the strangle (with delta still neutral) then the PnL is coming from the following:
Vega - given this is a -ve vega/short vol position a decrease in implied vols of both the OTM options in those couple of hours
+

results in a positive Pnl

Theta decay - this is technically the decrease in an option price in a given period of time "keeping all other factors constant".

In all likelihood given the current vol levels, Vega would've driven the 5pt Pnl profit more than theta given +

contribution from theta is low on a friday in a few hour period. Although one should note that theta depends on the level of vols and a high/low vol regime has a high/low theta.
I've seen some traders incorrectly assign their profits solely to theta when it's actually vega
+

that's driving their profits more. If you know where your profits/losses are coming from you can plan your next move accordingly in terms of adjustments etc. So as a simple example if your strangle, which you only entered to capture theta and intend to keep it from mkt open
+

to close, is losing money due its high vega at entry and with vols increasing (and assuming you're constantly adjusting to keep delta neutral) then you might want to reduce overall vega by shifting both strikes further away.

(END)