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

Pre - Market Analysis (30th Jan 2022)

1. U.S Markets closed higher on Friday. 2. Right now , dow futures are lower. 3. Asian markets are mixed. 4. SGX Nifty is up 30-50 Points. 5. There's no point discussing Global markets today. 6. As we are dealing with our own local issues as of now. 7. The talk of the town is Adani Group. 8. Every stock Market participant during last 2 days have not spent as much time with their wife /gf /husband /bf as they have spent on researching Adani stocks. 9. They shouldn't have wasted so much time in research and should've spent their time with loved ones. 10. As Ultimately my Pre Market report would clear all. 11. Now , the Adani stock price has gone below the FPO price. 12. FPO price is in the range of 3100-3200 and stock price is around 2800  13. Who will subscribe to FPO when they can buy shares much cheaper from the Market? 14. Also over the weekend Adani has come up with a 450 page report addressing one by one the allegations made by Hindenberg.  15. I haven't

Pre - Market Analysis (16th June 2022)

U.S Markets closed higher Yesterday. Right now Dow futures are higher by 140 points. Asian markets are higher. SGX nifty is indicating a gap up opening. Yesterday as anticipated Fed increased the interest rates by 75 basis points. This is the largest increase since 1994. There was a relief rally due to the same in U.S market and U.S VIX crashed 10%. How long will this relief rally go on is a big question. Our Markets were terrible yesterday. Everybody is shorting left , right and center. Yesterday all Put options premiums raised in last 30 mins. Even 15200 PE which is 500 points away from spot rose from 4rs to 13rs. Today we might get some short covering as we open and even head higher. 16000 should be a firm resistance for the day. I won't chase this gap up because when Market reverses it's with great speed. I'll look to short near 15950-15980 with a stoploss of 16020. In Bear markets the rallies sre quite ferocious but again markets make fresh lows. So remembe

Pre - Market Analysis (18th August 2022)

U.S Markets closed Flat Yesterday. Asian markets are mixed. SGX Nifty is close to 17940 right now. Yesterday markets broke out of 17900 and now are closer to 18000. 18000 is important as 18000 CE has the highest open interest. Highest amount of calls have been written for 18000 CE strike price. Plus round figures always act as psychological resistance too. Today is the weekly expiry and as of now the range is 17800 to 18000. 17800 is a strong support level and 18000 might act as resistance. Markets will gain steam once 18000 is taken out. Today could be a side-ways expiry. But nothing can be said as markets can always surprise you. IT Index has crossed 30k. Sensex yesterday hit a landmark of 60k. Sensex and Nifty both are now just 3% away from all time highs. So this isnt just a Bull Market , it's a raging Bull Market. India VIX closed below 18 yesterday. Bank Nifty is close to important levels of 40k. Once these important levels are taken out then we move towards all t