The option Greek Vega helps you trade implied volatility. Not many options traders use it, even though it can help you find winning trades.
The “Greeks” are incredibly helpful tools to use when calculating the probability of an options play. We have covered Delta, Gamma and Theta so far this year; now it’s time for Vega. Vega tells us an option’s sensitivity to a 1% change in the underlying asset’s implied volatility.
Option traders don’t talk much about Vega, because it is much harder to price implied volatility. (Stocks or other assets with high implied volatility have a much larger expected move, especially around events such as an earnings release.)
Additionally, Vega is used for longer-term options, which makes them more sensitive to changes in volatility.
How the options Greek Vega works
I buy options in Microsoft in front of their next earnings report. The options expire after the earnings report, but the chart looks solid. Those calls have higher implied volatility and thus a higher Vega. Both Vega and implied volatility get hammered after the earnings report.
Why does this happen and why is it important? For two reasons:
- The option seller (me) knows that when high volatility collapses, he cashes in on the premium.
- The stock owner might use the elevated Vega to sell calls against the stock. This allows portfolio managers to hedge risk and balance long and short positions to create a Vega zero portfolio.
So what is the value in option Vega?
Let’s say you have a call option priced at $1, with a Vega of .30. When the implied volatility increases by 2%, the option price will rise up by 60 cents (.30 x 2). So, a move from $1 to $1.60 is a solid 60% win (all other things being equal).
As you can see, calculating Vega allows you to place a winning trade based on whether implied volatility increases. Try paper trading with Vega and see how it works for you.
