A Glimpse of Vega2 min read
What is Vega?
Vega is the option Greek that explains the relationship between the price of an option and volatility changes in the underlying security. Theoretically, Vega gives the value by which the price of an option will change for every percentage point change in Implied Volatility (IV).
How Does One Use Vega?
Vega is related only to the extrinsic value of an option. When one is long options, one has a positive Vega. However, when one writes options, one has an effectively negative Vega.
Here’s an example. An option with a Vega value of 0.3 means that if the Implied Volatility increases by 1%, then the price of an option should increase by 0.3. It will also fall by 0.3 if the Implied Volatility decreases by 1%.
Which Factors Impact Vega?
There are two factors that affect Vega:
1. Moneyness
Vega is typically at it’s highest when the option is at the money, and then it reduces if the option contract moves into the money or out of the money. Vega reduces as the underlying price moves away from the strike price. As the extrinsic value of an option tends to be higher the closer it is to the money and the Vega only affects the extrinsic value of an option, it stands to reason that this would be the case.
2. Time to expiration.
For similar reasons, the Vega value will be higher when there is a long time left until expiration and lesser when there is less time left until expiration. The extrinsic value will reduce as the expiration date of the option approaches, it again makes sense that the Vega value will reduce accordingly.
Vega is closely related to gamma. If Gamma of an option is high, Vega also tends to be high.
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