One of the Greeks, vega measures the rate of change in an option’s theoretical value given a 1% change in implied volatility.
Vega is a strong contributor to option price movement day to day.
Just like the other trading greeks, vega values will be positive or negative depending on the strategy being implemented, where the strategy's strikes are in relation to the underlying price, and whether implied volatility is expanding or contracting.
Long options have positive vega. Short options have negative vega.
The key thing to remember is that vega is representative of extrinsic value changing (not intrinsic value).
If an option has a 0.05 vega and the expiration's Implied volatility drops from 50% to 45%, all else equal, the option will lose 25 cents of value.
When implied volatility increases, strategies that are net short premium (like credit spreads) will suffer from an increase in vega and extrinsic value. If an option or a spread is trading for MORE than it was sold for, this results in a marked loss. Keep in mind, however, that an expansion in IV does not necessarily mean a trader with a short premium setup will have a losing trade at expiration.
If a trader is in a long net premium trade, an IV expansion or increase in vega is typically beneficial.
If implied volatility collapses during the lifespan of a trade, this is beneficial to traders selling option premium (credit spreads). As IV decreases, vega and extrinsic value are also decreasing, so traders can often buy back their trades for CHEAPER than they sold it for.
On the other end, decreases in IV and vega are not beneficial to those in long premium trades.
Vega is always highest at the money, and trails off with deeper ITM strikes and further OTM strikes, just like extrinsic value.
Further dated expirations have higher vega values. As we get closer to expiration, the effect of vega starts to become very temporary.
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