Watch our video on how options vega affects options pricing.
Options vega is a part of the Greeks in options trading. Vega measure the rate of change in implied volatility for an options contract. It's a lot like how delta measures change in an options price. The video above goes more in depth on vega's role in options.
Options trading strategies give you the right but not the obligation to buy (call) or sell (put) a stock at a specified price (strike). Calls and puts are the bullish and bearish options you can use to trade stocks.
There are many moving parts to options that can affect profit and loss potential. However, options trading is less expensive than trading shares. The reason for this is you're paying a premium to control 100 shares instead of paying to own each share.
What Is Options Vega?
- The vega of stock options is measuring the rate of change in implied volatility.
- Implied volatility is the expected volatility of an option during the time you're in possession of it.
- In essence, options vega is showing you how much an options price will change with every 1% move of implied volatility.
- All the factors that go into determining the success of an options contract can be deterring to people.
However, options trading can be very rewarding if done right. Hence the need to study and practice trading in a simulated account. Options trading can be risky though.
The reason for this traders treating options contracts like shares when they aren't. There's so much more affecting the outcome than buying and selling.
For example, if you're looking at SQ calls that expire in four months. The current price is trading around $78. If you buy in the money with a strike price of $70 than the vega is 0.15.
This means that option contract will increase $0.15 for every 1% of increase in implied volatility. Let's say you're looking to go out of the money with an $80 strike price because you believe SQ will hit $80 in four months.
The Vega for that is 0.18. So the contract will increase $0.18 for every 1% implied volatility increases. Implied volatility represents price action. When price moves up, implied volatility increases and vise versa.
1. Options Vega & Using to Plan Strategies
It's said that picking the right strike price is the most important part of options trading. That's probably because 80% of all options contracts expire worthless.
Unless you're the seller of the option, you're most likely losing money. The reason for that is you may not be taking things like theta, gamma and delta into account; as well as the strike price you've picked (check out our stock market basics page).
However, making sure to look at things like open interest as well as volume among other things that help with making the right decision. Options are wasting assets because they expire.
Time only moves forward. Hence with each passing day, you're giving some profit to the seller of the option. Picking an out of the money strike price insures you're going to want volatility that makes the stock move in your favor.
If you're bought calls then the vega will be positive. If you're buying or selling puts, then the vega will be negative. At the money options, whether calls or puts, will have the highest vega because they'll get the most benefit from volatility. Take our options trading course.
2. Study and Practice
To new options traders, options vega can be confusing. In fact, all the different components to options trading can be. This is why paper trading options is so important.
Let's say you've gotten good at finding support and resistance. You believe the stock you're looking at has found support so you buy a call. If you've given yourself enough time, the delta could influence the options price for a positive gain.
If support is in fact strong, it stands to reason that the stock will move up from there. However, if vega wasn't factored into that trade you could find yourself losing.
Sometimes reversal rallies bring a large decline in implied volatility. So while you have a positive delta, the loss of vega could offset the delta gains and negatively impact your profit. You correctly predicted the change in direction but the Greeks took profits.
However, if you spend time studying how the Greeks affect profits and then apply that in a paper trading account, you'll go a long way in protecting yourself and your brokerage account.
There are many different options trading strategies. They allow you to make money in any market. Even sideways markets. As a result, while other traders are sitting on their hands waiting for the market to choose a direction, you can be making money.
Becoming a good options trader doesn't happen overnight. However, taking the time to learn and practice will allow you to make great return on investments without putting up a lot of capital. Have you taken a look at our trading service yet? We teach stock trading options live on our streams.
Why Is Vega Highest at the Money?
- Vega tells us an option's sensitivity to implied volatility. Implied volatility is the premium (extrinsic value) paid for the option. Hence why options Vega is highest at the money.
The Bottom Line
Options Vega is the measure of a price's change when implied volatility changes and IV is so important when selling options. It's important to understand how Vega can affect a trade when strategies can look the same based of delta. Understanding how the Greeks work can help to alleviate pain when it comes to trading options.