Implied volatility or the lack of it has been a hot topic for option traders over the past several months. If you are unfamiliar with IV and/or option vega, here is a brief explanation to get you up to speed.

Option Vega

Vega measures the impact implied volatility (IV) has on option premiums. Keeping it simple, for every 1% change in IV, vega will change the premium by that amount. If IV rises 1%, option premium will rise by the amount of vega. If IV falls 1%, option premium will drop by the vega amount. Because of this, long options, both calls and puts, have positive vega. An increase in option premium will help a long option position. Short options, both calls and puts, have negative vega. A decrease in option premium will help a short position. Buy low, sell high and vice versa, right? How can we use this as part of our option trading?

Buy low and sell high applies to IV as well. As an option trader, you want to buy premium when IV is considered cheap. Once in the position, you prefer IV rises to increase your premium. As a premium seller, you prefer IV to be high when premium is sold. Then you prefer IV to decline once the position is initiated.

Option Spreads

This also applies to multiple legs on your option trade. If your positive vega is bigger than all the negative vega, an IV increase helps the position whether it be a debit or credit spread. If your negative vega is bigger than all the positive vega, an IV decrease hurts the position for either a debit or credit spread.

Just like option gamma and theta, vega is highest at-the-money (ATM) and smaller in-the-money (ITM) and out-of-the-money (OTM). But unlike gamma and theta, vega gets bigger further out to expiration. So, a longer expiration means a larger vega number.

Final Thoughts

There is plenty more to add to this discussion on option vega. But just understanding this quick overview can make you more in tune with how to plan for what might happen to your position with a change in IV.

John Kmiecik, Market Taker Mentoring