Options Indicators
(the Greeks): Vega
Vega indicates the sensitivity of an option's fair
value to small changes in the option's implied volatility. Vega is often
expressed as the amount an option price would change given a one-percent
rise in implied volatility. Higher implied volatility generates higher
option prices because a higher implied volatility reflects a greater
propensity of the underlying to move significantly; this in turn implies
a higher probability that the option might end up in-the-money at
expiration.
- For long
calls and long puts: Vega is always positive;
- For short
calls and short puts: Vega is always negative;
- Underlying
(stock): Vega for stock is always zero.
Positive Vega: The value of a long option
increases when implied volatility increases; it decreases when
volatility decreases.
Negative Vega: The value of a short option
decreases when implied volatility rises; it increases when volatility
goes lower. The impact of changes in implied
volatility is greatest for options that are at-the-money and have a few
months left until expiration. Changes in implied volatility have a
smaller effect on options that are very close to expiration or on
options that are very far from expiration. If an option is considerably
in-the-money or out-the-money, the effects of changes in implied
volatility are also reduced. Because volatility
is one of the most important parameters that determine the price of an
option, a good knowledge of Vega is required. Vega can help you
determine which options are likely to yield the best rewards. One
crucial step is to compare an option's current implied volatility with
the underlying's volatility history. When an
asset has a very high implied volatility, you should look closely at the
options' Vega. For instance, you may be correct in your assessment that
an underlying could move appreciably higher, yet never ignore a very
elevated Vega reading. A long call you hold may actually lose money when
implied volatility suddenly collapses (this often happens immediately
following a highly anticipated earnings release where the options'
implied volatility rose considerably in anticipation of the earnings'
potential to move the stock).
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