Trading Options in Turbulent Markets: Master Uncertainty through Active Volatility Management

Chapter 7. Price Explosion: Volatility and Option Vega

Vega—the only greek that isn't represented by a real Greek letter—is an estimate of how much the theoretical value of an option changes when volatility changes 1 percent. Higher volatility means higher options prices. Why? Higher volatility results in a greater price swing in the underlying asset price, which translates into a greater likelihood for an option to be profitable by expiration. Lower volatility signifies lower options prices, for the inverse reason: Lower volatility implies a smaller swing in the underlying asset price, translating into less likelihood that the option will be profitable by its expiration date.

Long calls and long puts always have positive vega. Short calls and short puts always have negative vega. Stocks and futures have zero vega—their values are not affected by volatility. Positive vega means that the value of an option position increases when volatility increases and decreases when volatility decreases. Negative vega means that the value of an option position decreases when volatility increases, and it increases when volatility decreases (see Exhibit 7.1).

For example, look at the XYZ August 100 call. It has a value of $2.00 and a vega of 1.20 with the volatility of XYZ at 30 percent. If the volatility of XYZ rises to 31 percent, the value of the XYZ August 100 call will theoretically rise to $2.20. If the volatility of XYZ falls to 29 percent, the value of the XYZ August 100 call will drop to ...