Skip to main content

Option Greeks Explained (Vega)

Options Vega Explained

Option contract prices will increase as the probabilities of them expiring in-the-money are greater and will go down as the probabilities of them expiring in-the-money decreases. As options get closer to being in-the-money they capture more of their underlying assets move, as they get farther away from being in-the-money they capture less of their underlying assets move. High volatility increases the odds of an option having the ability to be in-the-money on expiration. Extreme volatility also increases the risk of loss to the option seller with a strong adverse move and an option price will increase to account for the higher risk and compensate the option seller for this risk.

Vega measures an option’s sensitivity when there are changes in volatility of the underlying asset.

Option vega is the measure of the amount of money per underlying share that an option contract value will gain or lose as price volatility rises or drops by 1 percentage point. Both call options and put options will increase in contract value when price volatility rises.

Vega can be one of the most important Greeks to understand and track for an option trader. During more volatile markets and charts the value of option strategies will be very price sensitive to changes in volatility, especially with extreme price range expansion. The cost of at-the-money options, and especially straddle and strangle option plays will become more expensive with changes in volatility on the underliers.

The volatility of an asset is measured by the magnitude and speed that price moves up or down, and can be based on any changes in the recent price range or historical prices in a stock or commodity future contract. Vega will change as there are large price changes in a stock or commodity an option is written on. Vega value in the price of an option will decrease as the option gets close to it’s expiration date or it gets past a risk event like earnings or any other important announcement that could cause a big price move. Vega is the component in pricing of options to account for the risk that a seller is taking on based on the current and estimated volatility of the underlying stock. Options increase in value during times of greater volatility and decrease in times of less volatility and after risk events have passed.

If you purchase a stock that is on a company that will announce its earnings before the options expire the expected volatility and the move of the price that is expected due to that event will be priced into the option. An at-the-money option will give you an idea of the expected move of a stock. If a stock is at 100 and an at-the-money 100 strike call option is normally 3 one week until expiration but earnings are before expiration and the 100 strike is 13 instead of the normal 3 then the odds are that the 3 is the normal theta value and the extra 10 is the vega value pricing in a 10 move after earnings. One thing that trips up new option traders is that that 10 Vega value will be almost completely gone when the option opens for trading the following morning after earnings are announced and digested on the chart.

The stock could open at $110 and your option still be worth $13 as your Vega value has been replaced by intrinsic value and you could still have $3 in theta value. To trade options through earnings you have to overcome the price of the volatility that will be gone after the event with enough intrinsic value of the option going in-the-money to be profitable. Some vega can also be priced into options before major events like Fed minutes, a congressional bill, a crop report, or a big jobs report. Always be aware that options are pricing in moves in time and volatility to compensate the option sellers for their risk taking. Option pricing is very efficient for the known volatility of events. It is the following of trends, systems, reactive technical analysis, and risk/reward ratios that can provide an edge.

Vega tends to expand and retract over time. Markets go from volatile to trending or range bound and back to volatile over time and vega tracks the risk in volatility by pricing it into options contracts. Peak vega pricing is with the at-the-money option in a chain and decreases as options get farther in-the-money or farther out-of-the-money as the probabilities change for the option expiring in the money due to volatility.

Comments

Popular posts from this blog

U.S Markets firing 🔥 (8th Feb 2024)

1. U.S Markets closed higher Yesterday. 2. U.S Markets are trading at their all time high on daily basis. 3. S&P 500 is now at 5k. 4. This has been a stellar show across the globe. 5. We have an Election Year in the U.S as well. 6. As you might not be aware more than 45% U.S citizens invest in stock market. 7. So for the Government to have a good impression and to gain vote Bank stock market have to be kept higher. 8. Government and FED will do what all they can to keep pro markets  9. Bank Nifty showed signs of comeback yesterday but the rally failed again. 10. Largecap stocks continue to underperform whereas Mid & Small caps continue to soar new highs. 11. Once a trend develops in the markets it can go on for a long time than expected. 12. Interestingly , I was doing some number crunching yesterday and found that small & mid cap companies have given better than expected results than large caps. 13. Most of the large caps have disappointed. 14. Star of the pack

Reversal from 20k (24th July 2023)

1. U.S Markets closed lower on Friday. 2. Dow Jones was flat. 3. Nasdaq was the underperformer. 4. Gift Nifty is down 30-40 Points. 5. Asian markets are mostly lower as well. 6. Friday the Nifty opened with a gap down of 200 points. 7. Within the next 10 minutes , Nifty recovered 100 points. 8. Bulls expected recovery is on the cards but Nifty started to Crack. 9. Bank Nifty was holding up Nifty for most of the while. 10. It couldn't be able to provide much of a support and Bank nifty also began to correct. 11. The issue now is market has had vertical rallies. 12. One way quick rallies so now the downfall will also be vertical. 13. When markets go up quick , they come down quicker. 14. Infy dragged the mood and also HUL didn't post extraordinary results so it was also a laggard. 15. Banks tried hard to hold the markets but couldn't. 16. Over the weekend , AU Bank and icici bank reported very good numbers. 17. These banks have already rallied a lot before results

Consolidation (2nd August 2023)

1. U.S Markets closed mixed Yesterday.  2. Dow Jones closed mildly in Green. 3. Rest of the indices closed lower. 4. Right now , Dow Futures is lower. 5. Gift Nifty is down 40-50 Points. 6. Asian markets are mostly lower as well. 7. It's a sort of Consolidation going on in the markets. 8. Markets are trading flat in between 19600 to 19800. 9. Within this range , Nifty is swinging like a pendulum. 10. Bank Nifty range is 45300 to 45800. 11. Both the Indices are moving at tandem. 12. Yesterday's expiry was quite flat. 13. FIN Nifty traded flat for whole of the expiry. 14. All option buyers in FIN Nifty lost huge. 15. Markets are likely to consolidate for few more sessions. 16. 19600 is the buying zone. 17. 19800 is the selling zone. 18. Unless we don't get any signs of range breakout we won't have to take one side view  19. Nifty might trade between 19600 to 19800 today. 20. Post this fed rate hike markets have become dizzy. 21.  stockmarketadvisory.in