Vega is the change in the value of an option for a 1-percentage point increase in implied volatility of the underlying asset price. Implied volatility is measured as the annualized standard deviation of an assetís daily price changes. The Vega of a long option position (both calls and puts) is always positive.
At-the-money options have the greatest Vega. The further an option goes "in-the-money" or "out-of-the-money", the smaller is the Vega. As time passes, Vega decreases. Time amplifies the effect of volatility changes. As a result, Vega is greater for long-dated options than for short dated options.
As volatility falls, Vega decreases for in-the-money and out-of-the-money options; Vega is unchanged for at-the-money options.
- Vega is the optionís change in theoretical value with a change in volatility
- Most options have a positive Vega because they gain value with rising volatility and lose with falling volatility
- Vega of most options decline as time to expiration grows shorter
Vega tells us approximately how much an option price will increase or decrease given an increase or decrease in the level of implied volatility. Option sellersí benefit from a fall in implied volatility, and itís just the reverse for option buyers.
Vega can increase or decrease even without price changes of the underlying because implied volatility is the level of expected volatility.