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Options Vega: What Is Vega & How to Measure it?
What is Vega?
Vega measures an option's sensitivity to changes in the implied volatility of the underlying asset. While vega is included in the group of "Greeks" used in option analysis, it is the only one not represented by an actual Greek letter.
Vega essentially reports on the sensitivity of an option to fluctuations in volatility. A higher vega value implies that the option price will be more sensitive to changes in volatility, while a lower vega indicates that the option price will be less sensitive to changes in volatility.
In the options universe, the “Greeks” refer to a group of parameters that measure risk in an options position. The Greeks are typically used to help investors and traders risk-manage individual options positions, as well as the overall portfolio.
The Greeks are referred to as such because each dimension of risk is represented by a Greek letter. The primary Greeks are: delta, gamma, theta, vega and rho.
How Does Vega Work?
Vega is typically expressed as the amount of money per underlying share that the option's value will gain or lose as volatility rises or falls by 1%.
Owned options (both calls and puts) have positive vega, which means they typically increase in value when volatility increases, and decrease in value when volatility decreases. Short options (both calls and puts) have negative vega, and work in the opposite fashion—they theoretically decline in value when volatility increases, and increase in value when volatility decreases.
A trader that believes implied volatility will increase might therefore gravitate toward owning options with higher vega, to benefit from that potential scenario.
Conversely, traders who anticipate a decrease in volatility might prefer to own options with lower vega to mitigate against potential losses from declining prices. Alternatively, a trader expecting a decline in implied volatility might elect to sell an option, to capitalize on a potential drop in volatility.
Options with longer dated maturities generally have a higher percentage of vega than closer dated maturities. Additionally, vega is typically higher for at-the-money (ATM) options as compared to out-of-the-money (OTM) options.
Vega Option Example
Vega is the Greek that measures an option's sensitivity to the changes in the volatility of the underlying. Vega is typically expressed as the amount of money that an option's value will gain or lose when volatility rises or falls by 1%.
For example, imagine a trader owns a hypothetical call option with a vega of 0.05. That means that for every 1% increase in implied volatility, the option's price is expected to increase by $0.05, assuming all other factors remain constant.
On the other hand, if implied volatility were to decrease by 1%, the option's price would be expected to decrease by the same amount.
Now assume the option is currently priced at $2.00 with an implied volatility of 20%. If the implied volatility of that option were to increase from 20% to 21%, the value of the option would theoretically increase from $2.00 to $2.05, all else being equal.
Vega's Impact on Option Pricing
Owned options (both calls and puts) have positive vega, which means they typically increase in value when volatility increases, and decrease in value when volatility decreases. Short options (both calls and puts) have negative vega, and work in the opposite fashion—they theoretically decline in value when volatility increases, and increase in value when volatility decreases.
Options with longer dated maturities generally have a higher percentage of vega than closer dated maturities. Additionally, vega is typically higher for at-the-money (ATM) options as compared to out-of-the-money (OTM) options.
A trader that believes implied volatility will increase might therefore gravitate toward owning options with higher vega, to benefit from that potential scenario.
Conversely, traders who anticipate a decrease in volatility might prefer to own options with lower vega to mitigate potential losses from declining prices. Alternatively, a trader expecting a decline in implied volatility might elect to sell an option, to capitalize on a potential drop in volatility.
Positive and Negative Vega
Vega essentially reports on the sensitivity of an option to fluctuations in volatility. A higher vega value implies that the option price will be more sensitive to changes in volatility, while a lower vega indicates that the option price will be less sensitive to changes in volatility.
Owned options (both calls and puts) have positive vega, which means they typically increase in value when volatility increases, and decrease in value when volatility decreases. Short options (both calls and puts) have negative vega, and work in the opposite fashion—they theoretically decline in value when volatility increases, and increase in value when volatility decreases.
Vega and Implied Volatility
Vega is the Greek that measures an option's sensitivity to the changes in the volatility of the underlying. Vega is typically expressed as the amount of money that an option's value will gain or lose when volatility rises or falls by 1%.
In the options world, implied volatility refers to the market price of volatility, and is often quoted alongside the dollar and cents value of an option. When implied volatility changes—whether up or down—that typically impacts the value of the option.
For example, imagine a trader owns a hypothetical call option with a vega of 0.05. That means that for every 1% increase in implied volatility, the option's price is expected to increase by $0.05, assuming all other factors remain constant.
On the other hand, if implied volatility were to decrease by 1%, the option's price would be expected to decrease by $0.05.
Now assume the option is currently priced at $2.00 with an implied volatility of 20%. If the implied volatility of that option were to increase from 20% to to 21%, the value of the option would theoretically increase from $2.00 to $2.05, all else being equal.
VEGA WHEN IV INCREASES
In this context, “IV” refers to “implied volatility,” which is is the market price for volatility, and is often quoted alongside the dollar and cents value of an option.
Owned options (both calls and puts) typically increase in value when implied volatility increases, and decrease in value when implied volatility decreases.
Short options work in the opposite fashion—they theoretically decline in value when volatility increases, and increase in value when volatility decreases.
VEGA WHEN IV DECREASES
If implied volatility collapses during the lifespan of a trade, this is beneficial to traders selling option premium (credit spreads). As IV decreases, vega and extrinsic value are also decreasing, so traders can often buy back their trades for CHEAPER than they sold it for.
On the other end, decreases in IV and vega are not beneficial to those in long premium trades.
FAQ
What does vega mean for options?
Vega measures an option's sensitivity to changes in the implied volatility of the underlying asset. While vega is included in the group of "Greeks" used in option analysis, it is the only one not represented by an actual Greek letter.
Vega essentially reports on the sensitivity of an option to fluctuations in volatility. A higher vega value implies that the option price will be more sensitive to changes in volatility, while a lower vega indicates that the option price will be less sensitive to changes in volatility.
Is higher vega good for options?
A higher vega value implies that the option price will be more sensitive to changes in volatility, while a lower vega indicates that the option price will be less sensitive to changes in volatility.
For long (owned) options, that means an increase in implied volatility is typically good for an option, as it will likely increase the value of that option.
A trader that believes implied volatility will increase might therefore gravitate toward owning options with higher vega, to benefit from that potential scenario.
Conversely, traders who anticipate a decrease in volatility might prefer to own options with lower vega to mitigate against potential losses from declining prices. Alternatively, a trader expecting a decline in implied volatility might elect to sell an option, to capitalize on a potential drop in volatility.
What is the difference between vega and volatility?
Implied volatility is a measure of the market's expectation of future price volatility of the underlying asset, and is implied by the prices of options in the market.
Implied volatility therefore reflects supply and demand dynamics in the options market, and is often quoted alongside the dollar and cents value of an option.
Vega, on the other hand, reports on the sensitivity of an option to fluctuations in volatility.
A higher vega value implies that the option price will be more sensitive to changes in volatility, while a lower vega indicates that the option price will be less sensitive to changes in volatility.
Owned options (both calls and puts) have positive vega, which means they typically increase in value when volatility increases, and decrease in value when volatility decreases. Short options (both calls and puts) have negative vega, and work in the opposite fashion—they theoretically decline in value when volatility increases, and increase in value when volatility decreases.
For example, imagine a trader owns a hypothetical call option with a vega of 0.05. That means that for every 1% increase in implied volatility, the option's price is expected to increase by $0.05, assuming all other factors remain constant.
On the other hand, if implied volatility were to decrease by 1%, the option's price would be expected to decrease by $0.05.
Now assume the option is currently priced at $2.00 with an implied volatility of 20%. If the implied volatility of that option were to increase from 20% to to 21%, the value of the option would theoretically increase from $2.00 to $2.05, all else being equal.
What is bad vega in options?
Vega isn’t typically qualified as “good” or “bad.” Instead, Vega reports on the sensitivity of an option to fluctuations in volatility.
A higher vega value implies that the option price will be more sensitive to changes in volatility, while a lower vega indicates that the option price will be less sensitive to changes in volatility.
How to use vega?
Vega can be a valuable tool when trading options because it can be used to help estimate the impact of changes in implied volatility on option prices.
When constructing options strategies, one can evaluate whether a high vega better suits the strategy, or whether low vega is more appropriate. That will depend on the trader’s outlook for volatility, and the trading approach/strategy in question.
A trader that believes implied volatility will increase might therefore gravitate toward owning options with higher vega, to benefit from that potential scenario.
Conversely, traders who anticipate a decrease in volatility might prefer to own options with lower vega to mitigate against potential losses from declining prices. Alternatively, a trader expecting a decline in implied volatility might elect to sell an option, to capitalize on a potential drop in volatility.