Key Concepts 4. Portfolio Management

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Vega

Vega is the greek metric that allows us to see our exposure to changes in implied volatility. Vega values represent the change in an option’s price given a 1% move in implied volatility, all else equal. Long options & spreads have positive vega. Example strategies with long vega exposure are calendar spreads & diagonal spreads. Short options & spreads have negative vega. Some examples are short naked options, strangles, straddles, iron condors & short vertical spreads.

When thinking about vega, we have to remember that implied volatility is a reflection of price action in the option market. When option prices are being bid up by people purchasing them, implied volatility will increase. When options are being sold, implied volatility will decrease. With that said, when being long options we want the price of the option to increase. When being short options we want the price of the options to decrease. That is why long options have a positive vega, and short options have a negative vega. An increase in implied volatility will benefit the long option holder, as that indicates an increase in option pricing, hence the positive vega assignment. A decrease in implied volatility will benefit the short option holder, as that indicates a decrease in option pricing, hence the negative vega assignment.

Since we normally hold a short vega portfolio as option sellers, we are exposed to volatility increases. We have to be careful with this exposure as volatility generally has velocity to the upside. This means volatility can quickly spike up, as it usually has a negative correlation with the market, which tends to have velocity to the downside. Managing our vega is important to ensure that we don’t have more exposure than we’re comfortable with from a portfolio perspective.

Vega Videos