Vega is the Greek that measures how much an option's price changes when implied volatility changes. While Delta and Gamma focus on stock price movements, Vega focuses on volatility - often the most misunderstood yet powerful factor in options pricing. Mastering Vega can give you a significant edge, especially around earnings and market events.
What is Vega?
Vega measures the change in an option's price for every 1% change in implied volatility (IV). If an option has a Vega of 0.15, the option price will increase by $0.15 when implied volatility rises by 1%, and decrease by $0.15 when IV falls by 1%.
Key insight: Vega is always positive for both calls and puts. When volatility rises, all options become more valuable because there is a greater chance of large price movements in either direction.
Understanding Implied Volatility
Before diving deeper into Vega, it is important to understand implied volatility (IV). IV represents the market's expectation of future price movement. Higher IV means traders expect bigger moves, which makes options more expensive.
- High IV: Options are expensive, markets expect big moves (earnings, news events)
- Low IV: Options are cheap, markets expect calm conditions
- IV Rank/Percentile: Compares current IV to historical IV to determine if options are relatively cheap or expensive
How Vega Affects Your Trades
Vega impact depends on whether you buy or sell options:
For Option Buyers (Long Vega)
- You benefit when implied volatility increases
- Rising IV can make you money even if the stock does not move much
- Falling IV hurts you, even if the stock moves in your favor
For Option Sellers (Short Vega)
- You benefit when implied volatility decreases
- IV crush after events like earnings can be very profitable
- Rising IV hurts your position as options become more expensive
Example: Vega Before Earnings
Stock ABC is at $100 with earnings tomorrow. You buy a call option for $3.00 with Vega of 0.20.
- Before earnings: IV is 60%
- After earnings: IV drops to 40% (common IV crush)
- Vega impact: 0.20 x 20 = $4.00 loss from IV alone
Even if the stock goes up $2 and you gain from Delta, the $4 loss from Vega can wipe out your profits. This is why buying options before earnings is often unprofitable.
When is Vega Highest?
Several factors determine how much Vega an option has:
1. Time to Expiration
Longer-dated options have higher Vega. LEAPS (options expiring in 1-2 years) are extremely sensitive to IV changes. Short-term options have lower Vega because there is less time for volatility to impact the price.
2. Moneyness
At-the-money (ATM) options have the highest Vega. Deep ITM and far OTM options have lower Vega because their prices are more determined by intrinsic value or probability of worthlessness.
3. Current Volatility Level
Vega itself can change based on the level of IV. This is measured by a higher-order Greek called "Vomma" or "Volga."
Pro tip: When IV is at extreme lows, buying options can be attractive because you have positive Vega exposure - any return to normal volatility will increase your option value. Conversely, when IV is at extreme highs, selling options captures the premium with less risk of IV expanding further.
Vega Trading Strategies
Understanding Vega opens up several trading strategies:
Long Vega Strategies
- Long straddles/strangles: Profit from volatility expansion
- Calendar spreads: Benefit when front-month IV rises faster than back-month
- Buying options when IV is low: Get cheap exposure to potential volatility spikes
Short Vega Strategies
- Iron condors: Profit from IV crush after events
- Credit spreads: Benefit from declining volatility
- Selling straddles/strangles: Maximum profit from IV collapse
Example: Selling Vega Before Earnings
Stock XYZ has earnings next week. IV is at 80% (very high). You sell an iron condor and collect $3.00 premium with total Vega of -0.25.
- After earnings: IV drops from 80% to 35%
- Vega profit: 0.25 x 45 = $11.25 per share
The IV crush alone generates significant profit, even before considering Theta decay. This is why selling premium before earnings is popular among experienced traders.
Vega in Multi-Leg Positions
When you trade spreads, your net Vega is the sum of individual leg Vegas:
- Vertical spreads: Generally low Vega because long and short options partially offset
- Calendar spreads: Positive Vega (long back-month, short front-month)
- Diagonal spreads: Can be Vega positive or negative depending on structure
- Iron condors: Negative Vega (short options dominate)
Common Vega Mistakes
- Buying options right before earnings: IV is usually highest before earnings and crashes afterward, hurting option buyers.
- Ignoring IV levels: Not checking if options are cheap or expensive before trading leads to overpaying.
- Holding through volatility events: If you bought options for a move but IV is about to collapse, consider closing before the event.
- Not understanding calendar spread Vega: Calendar spreads can lose money if IV collapses despite being time decay positive.
Vega vs. Historical Volatility
Remember that Vega relates to implied volatility, not historical (actual) volatility. These two can diverge significantly:
- When IV > historical: Options are "expensive" - favor selling
- When IV < historical: Options are "cheap" - favor buying
- After events like earnings, IV often resets lower regardless of how much the stock actually moved
Track Vega Across Your Portfolio
Pro Trader Dashboard shows you the Vega for each position and your total portfolio Vega exposure. Understand how volatility changes will impact your account before they happen.
Summary
Vega measures your exposure to volatility changes. Option buyers have positive Vega (benefit from rising IV), while sellers have negative Vega (benefit from falling IV). Understanding Vega is essential for trading around earnings, market events, and optimizing your entry timing based on whether options are cheap or expensive.
Complete your Greeks education with our guides on Delta, Gamma, and Rho.