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From Theory To Practice

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An Intuitive Understanding of Vega

From Theory To Practice

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

Today, we continue our discussion centered around gaining an intuitive understanding of some of the greeks that we use on a daily basis. We talked about delta in depth and detail, and we learned of its power in measuring directional risk and probabilistic outcomes. We also examined theta, and we explored its relationship to duration, time value, and time decay. In this segment, we do the exact same thing with vega.

What we learn is that vega is directly related to volatility. It shows us just how our positions (or portfolio) would respond to a change in volatility. Specifically, vega measures how much an option’s price is expected to move given a 1% move in volatility. If you are “long vega”, then you are long volatility, and you benefit from volatility expansion. If you are “short vega”, then you are short volatility, and you benefit from volatility contraction. We work through a couple of examples using TSLA and TLT to show exactly how vega works.

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