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What is Options Vega?
Vega is a measure of the impact of changes in implied volatility on the option price. Specifically, the vega of an option expresses the change in the price of the option for every 1% change in implied volatility.
Options tend to be more expensive when volatility is higher. Thus, whenever volatility goes up, the price of the option goes up and when volatility drops, the price of the option will also fall.
Example
A stock XYZ is trading at $46 in May and a JUN 50 call is selling for $2. Let’s assume that the vega of the option is 0.15 and that the underlying volatility is 25%.
If the underlying volatility increased by 1% to 26%, then the price of the option should rise to $2 + 0.15 = $2.15.
However, if the volatility had gone down by 2% to 23% instead, then the option price should drop to $2 – (2 x 0.15) = $1.70
Passage of time and its effects on the vega
The more time remaining to option expiration, the higher the vega. This makes sense as time value makes up a larger proportion of the premium for longer term options and it is the time value that is sensitive to changes in volatility.
