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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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The Information on the Site is provided for information purposes only. The Information is not intended to be and does not constitute financial advice or any other advice. The trading of stocks, futures, commodities, index futures or any other securities has potential rewards, and it also has potential risks involved. Trading may not be suitable for all users of this Website. Past performance is not necessarily an indication of future performance. You absolutely must make your own decisions before acting on any information obtained from this Website.

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