Skip to main content

Vega

Vega: Sensitivity to Volatility in Options​

Vega is a key option Greek that measures the sensitivity of an option’s price to changes in implied volatility. It indicates how much an option’s premium will change for every 1% change in implied volatility.

Example:
If an option has a Vega of 0.10, a 1% increase in volatility will increase the option’s price by ₹0.10, and vice versa.

Impact of Vega​

  • Positive Vega: Both call and put options have positive Vega, meaning their premiums increase as implied volatility rises.
  • Highest at ATM: Vega is highest for At-The-Money (ATM) options and decreases for In-The-Money (ITM) or Out-of-The-Money (OTM) options.
  • Longer-Term Options: Options with more time until expiration have higher Vega because they are more sensitive to changes in implied volatility than shorter-term options.

Vega becomes particularly important in environments where volatility is expected to rise or fall significantly, such as:

  • Before earnings announcements.
  • During major economic reports.
  • Amid geopolitical events.

An increase in implied volatility raises the prices of both calls and puts, while a decrease in volatility lowers them.

Practical Example​

Suppose a stock is trading at ₹500, and you are considering a call option with:

  • Strike Price: ₹500 (ATM).
  • Current Option Price: ₹20.
  • Vega: 0.15.
  • Time to Expiry: 30 days.

If implied volatility increases by 5%, the option price will rise by:

Price Increase = 0.15 × 5 = ₹0.75

The new option price becomes:

₹20 + ₹0.75 = ₹20.75

If implied volatility decreases by 5%, the option price will drop by ₹0.75, making the new price ₹19.25.

Vega and Risk Management​

Vega is crucial for traders, especially those using volatility-based strategies:

  • If volatility is expected to rise: Buy options to profit from increased premiums.
  • If volatility is expected to fall: Sell options to capitalize on decreasing premiums by buying them back at lower prices.

Vega and Expiry Time​

Vega has a stronger influence on options with longer time until expiry because there is more time for volatility to impact the option’s price. As the expiration date approaches:

  • Vega decreases due to reduced time for significant price movements.
  • Short-term options are less impacted by volatility changes.

Conclusion​

Vega measures how sensitive an option’s price is to changes in implied volatility, providing traders with critical insights into market conditions. Understanding Vega enables traders to make informed decisions when volatility is expected to change, whether buying options to profit from increased premiums or selling them to capitalize on decreased volatility. In high-volatility scenarios, options become more expensive due to increased uncertainty, offering opportunities for profit or risk mitigation.