Vega

Vega is one of the key Greeks used by traders on platforms like m.Stock to assess how sensitive an option’s premium is to changes in implied volatility. It's crucial to distinguish between volatility, which refers to the actual market fluctuations, and Vega, which measures how much an option’s price is expected to change when implied volatility shifts by 1%.

Understanding Vega in Options

Implied volatility is a core input in option pricing. If the underlying asset is expected to move sharply, this uncertainty drives up implied volatility, making the options more expensive and increasing Vega. In contrast, lower market uncertainty reduces implied volatility and, accordingly, the Vega of the option.

Example:
Suppose an option is priced at ₹10 with a Vega of 0.10.

• If implied volatility drops from 50% to 25%, the option value may decrease by ₹0.50, resulting in a new premium of ₹9.50.
• If implied volatility increases from 25% to 50%, the option premium might rise to ₹10.50.

Also note:

• Long options have positive Vega—,  the buyer benefits from increased volatility.
• Short options have negative Vega—,  the seller benefits from reduced volatility.
• For the same strike price and expiry, Vega remains equal for both call and put options. For example, an August-end Nifty 17,900 strike call and put would have the same Vega—,  say, 10.38.

Vega, Moneyness, and Expiration

Time to Expiry and Vega

The time remaining until expiry significantly influences Vega.

• Long-dated options carry higher Vega because they embody more uncertainty and have greater exposure to changes in volatility.
• As expiration nears, the time value diminishes, reducing Vega.

Moneyness and Vega

Vega peaks when the option is at-the-money (ATM).

• ATM options are highly responsive to volatility changes.
• Out-of-the-money (OTM) options have lower Vega because a large price movement is needed for them to become profitable.
• In-the-money (ITM) options also have low Vega as their premium consists mostly of intrinsic value, not extrinsic.

Since Vega is tied to extrinsic value, it plays a smaller role in deep ITM options.

Using Vega in Options Trading

Understanding Vega is essential for building multi-legged option strategies and for risk assessment.

• Long Vega positions (e.g., buying calls or puts) benefit from rising implied volatility, which increases option premiums.
• Short Vega positions (e.g., writing calls or puts) gain when implied volatility decreases, leading to premium erosion.

Strategy Insight

• If you hold a long Vega position when implied volatility is already high, you risk losses if volatility contracts.
• Conversely, a short Vega position entered during low implied volatility may suffer if volatility rises.

Best Practices:

• Open long Vega trades like long straddles when implied volatility is low and expected to increase.
• Opt for short Vega trades like short straddles when implied volatility is high and anticipated to fall.

Points to Remember

• Vega measures how much an option’s premium changes with a 1% shift in implied volatility.
• Volatility is the actual market movement; :  Vega is the sensitivity measure.
• Long options = positive Vega; Short options = negative Vega.
• Vega is identical for calls and puts with the same strike and expiry.
• Vega is higher for longer-term options and falls as expiration nears.
• ATM options have the highest Vega, while OTM and ITM options carry lower Vega.