Net volatility

Net volatility refers to the volatility implied by the price of an option spread trade involving two or more options. Essentially, it is the volatility at which the theoretical value of the spread trade matches the price quoted in the market.

Formula

The net volatility for a two-legged spread (with one long leg, and one short) can be estimated, to a first order approximation, by the formula:

$\sigma _{N}={\frac {\nu _{L}\sigma _{L}-\nu _{S}\sigma _{S}}{\nu _{L}-\nu _{S}}}\,$

where

$\sigma _{N}$ is the net volatility for the spread

$\sigma _{L}$ and $\nu _{L}$ are the implied volatility and vega for the long leg

$\sigma _{S}$ and $\nu _{S}$ are the implied volatility and vega for the short leg