In options trading, traders are often presented with Greek letters that represent mathematical measures of the sensitivity of the option price to different variables, which are products of the option pricing model, and through these measures, option traders can more accurately assess the risk exposure of the option and construct the appropriate risk management as well as trading strategies.
The Greek letters commonly used in options trading are as follows: Delta (Δ), Gamma (Γ), Theta (Θ), Vega (ν), Rho (ρ). The connotations of Vega (ν) are described below.
Option P&L = Delta P&L + Gamma P&L + Vega P&L + Theta P&L + other small factors P&L.
Vega (ν)
Definition:Vega is the partial derivative of the option price with respect to the implied volatility.
Meaning: The Vega value is used to measure the sensitivity of the option price to implied volatility. It indicates the change in option price as a result of a change in implied volatility. Please pay attention to the difference between historical volatility and implied volatility. Call and put options have the same Vega value, which is characterized by two features: the option Vega value is always positive, and the Vega value is highest near parity.
e.g. if the value of an option is 7.50, implied volatility is at 20 and the option has a Vega of .12.
Assume that implied volatility moves from 20 to 21.5. This is a 1.5 volatility increase. The option price will increase by 1.5 x .12 = .18 to 7.68.
Conversely, if volatility dropped from 20 to 18. This two-point decrease times .12 equals .24, making the option premium 7.26.
Vega is the highest when the underlying price is near the option’s strike price. Vega declines as the option approaches expiration. The more time to expiration, the more Vega in the option.
Application: With the Vega value, option traders can buy the corresponding straddle and wide straddle option combinations to go long volatility when they expect market volatility to increase. Conversely, an option trader can sell the corresponding straddle and wide straddle option combinations to go short volatility when the market volatility is expected to decrease.
