04/04/24 08:59 AM EDT

TERM OF THE DAY: OPTIONS VEGA

Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here.

Vega is one of the Greeks used in options trading to measure the sensitivity of an option's price to changes in the underlying asset's implied volatility.

Specifically, Vega represents the dollar amount by which the option price will change for a one percentage point change in implied volatility, all else being equal.

For example, if an option has a Vega of 0.10, and the implied volatility rises by 1 percentage point (e.g. from 20% to 21%), the option's price would theoretically increase by $0.10.

Some key points about Vega:

Vega is highest for at-the-money options and decreases as options move in or out-of-the-money.
Long options have positive Vega, meaning they benefit from rising implied volatility. Short options have negative vega and suffer from volatility increases.
Vega tends to be higher for options with more time to expiration since there is greater volatility risk over a longer period.
Changes in Vega accelerate closer to expiration as time decay increases.

The effect of Vega is that rising implied volatility increases option premiums while falling volatility reduces premiums. This is because higher volatility increases the expected range of price movement, making options more valuable.

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