In options trading Option Vega measures the change in the price of a stock option relative to a 1% change in volatility. An easy way to remember this connecting is to remember that the “V” in VEGA stands for Volatility. Vega increases when there are large movements in the underlying stock and/or if major news events are expected to create dramatic swings in the underlying stock.
How Vega Changes For Strike Prices and Expiration Months
As most of you probably already know, Vega belongs to a group of option pricing measurements called “the Greeks”. Since time until expiration also plays into the pricing of Vega, longer expiration options generally have larger Vega values. In addition, the Vega is the highest for at the money options.
From the chart you can see that Vega is low for deep Out-of-the-Money options with little time until expiration and high for At-the-Money Options with a long time until expiration. This is because the later set of options has the highest probability or likelihood of making a large swing during the 60 days until expiration. The OTM options are constrained by time and therefore have a low Vega or reaction to increases in volatility.
Why Should You Care About Vega?
Most options traders will try to buy options to take advantage of a large potential move. Consequently, the option price increases because of the increase in volatility. As classic example of this is to attempt to buy options well in advance of an earnings announcement you think will be important. More experienced traders will actually use the increase volatility to sell options far out-of-the-money. These options will briefly become very valuable with the increased Vega and thus represent a great opportunity to collect premiums for money income. When the implied volatility of an option is near the high end of its 52-week range, you should favor selling strategies.
Leave A Reply (Be The First )
No comments yet