vega
Description
The vega describes the change in the value of the option when the volatility changes. The volatility represents how large the swings are in the underlying asset and is the cornerstone in option pricing. Larger swings imply that the underlying asset is more likely to take on more extreme values. While the option holder's risk is limited to the premium, his/her upside is unlimited for vanilla options. Hence, an increase in the volatility of the underlying asset increases the value of the option. As the table below suggests, the sensitivity is larger the closer to ATM the option is and the longer it has until it expires.
Technical Description
The derivative of the option price with respect to the volatility.
The Vega across Time/Delta |
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Time |
50 Delta |
25 Delta |
10 Delta |
1W |
5.5 |
4.4 |
2.4 |
1M |
12 |
9.1 |
5 |
3M |
20 |
16 |
8.6 |
6M |
28 |
22 |
12 |
12M |
38 |
30 |
17 |
Nominal Vega across Time/Delta |
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Time |
50 Delta |
25 Delta |
10 Delta |
1W |
550 |
440 |
240 |
1M |
1200 |
910 |
500 |
3M |
2000 |
1600 |
860 |
6M |
2800 |
2200 |
1200 |
12M |
3800 |
3000 |
1700 |
Amounts above are for a contract of 1 million. |
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Both tables show the change in the value of the option when the volatility changes by one Vol - i.e. if the implied volatility for the EUR/USD was to change from 9% to 10%. The first table reports the change in 1/100th of a percent of the notional amount of the option, whereas the second table states the absolute amount of the change in the value of an option with a notional amount of 1 million.
From the tables above it is clear that the sensitivity of the option with respect to volatility depends on i) the time to expiration and ii) the delta of the option.
- The longer the time to expiry, the more impact an increased volatility will have on the option price since the downside is limited to the premium paid while the upside is unlimited.
- For options far OTM or deep ITM it is unlikely that the increase in volatility will change whether or not the holder of the option chooses to exercise or not. Therefore the change in the value of these options is not as great as for the ATM options.