What is Vega in Options and How Does it Work?

Implied volatility and uncertainty are directly correlated and can drastically affect options prices. Implied volatility is an annual representation of expected stock price movement, on a one standard deviation basis. An implied volatility of 20% on a $100 stock price implies a stock price range between $80-120 over the course of a year.

Traders can see how implied volatility can affect their options positions during order entry by referring to Vega, which measures the change of an options price after a 1% change in implied volatility in the expiration they’re trading. For example, a trader with a long call with a Vega of 0.2 would see the price of their call options rise by $0.20 ($20 total) if the implied volatility in the expiration they’re trading rose by 1%.

When there is heightened uncertainty, Vega becomes more pronounced and reflects in an options' price. Vega exposure can be elevated when there are upcoming economic events, such as monthly job report announcements or interest rate changes, that can affect all stocks and the market. Additionally, any binary events potentially affecting a specific company's stock—like an upcoming earnings event—can elevate Vega exposure in options strategies. This is because implied volatility is heightened due to the unknown result of the event taking place, and after the event takes place implied volatility can get crushed, as the result is now known.

An option’s implied volatility (IV) measures the market's expectation of the option’s price volatility using the Black-Scholes options pricing model. IV is expressed as a percentage and can be considered a market's implied 1-standard deviation range for the asset price in one year.

IV is important for options traders because it directly affects the option's price. When IV is high, options tend to be more expensive relative to the underlying's price; when IV is low, options tend to be less expensive relative to the underlying’s price. A higher IV implies a more significant potential for the underlying asset's price to make a considerable move, while a lower IV implies a lower potential for substantial movement.

While viewing the IV of an individual option can help traders gauge the market's sentiment for uncertainty, traders can see the impact of IV by referring to the expected move listed in the Table mode of the tastytrade trading platform. The expected move is the theoretical ± price move of the underlying based on the options’ prices. At the same time, the IVx provides a blended IV rate to inform traders where the implied volatility stands within each expiration series.

While the expected move is not a guaranteed metric, it can inform traders what the options market is pricing in and if any upcoming binary events could affect implied volatility. This is illustrated below with an underlying that has an upcoming earnings announcement. The expected move for the expiration beneath the purple earnings indicator displays a larger IVx of 38% vs. 26.8% the week before. Moreover, the expected move of ±21.79 is double the prior week and visually represented within the options chain (orange outline). The larger IVx and expected move reflect the uncertainty surrounding how the stock will react to the upcoming earnings announcement.

In options trading, most strategies will either result in long Vega or short Vega. That said, it is crucial to recognize that implied volatility does not automatically rise when prices fall. Implied volatility can also rise when prices rise too. In short, it boils down to price uncertainty and how markets are moving relative to what was expected prior to the movement.

Long options positions established for a net debit—such as long calls or puts, vertical debit spreads, long straddles, long strangles—provide long Vega exposure. Long Vega trades tend to be very directional and look to profit from an extreme or sharp move that favors their options positions by appreciating in value. Long Vega tells you that if IV increases, it should benefit the options strategy, all else equal. If IV decreases, long Vega positions can show losses, all else equal.

On the other hand, traders with short options positions established for a net credit are short Vega. Some examples of short options strategies include selling naked calls or puts, vertical credit spreads, short straddles, short strangles, and other multi-legged options strategies resulting in a credit, providing short Vega exposure. Short Vega traders believe the market overstates volatility and inflates options prices. As a result, short Vega traders aim to profit by selling options when options prices are inflated and can profit if implied volatility collapses, all else equal. If implied volatility expands, short Vega strategies can show losses, all else equal.

Since options quote with a long bias, Vega will display as a positive number when viewing the options chain in the Trade tab using Table mode. As a result, traders establishing any options position for a net debit will have positive Vega, while short options trades will provide negative Vega exposure.

Vega can help traders gauge the amount of market uncertainty about a specific underlying. One instance of elevated Vega is when a company has an upcoming binary event like an earnings announcement. Since earnings events drum up uncertainty about how the market will react, Vega becomes more pronounced. In the example below using the 425-strike put, the Vega for the week before earnings is less prominent than the week spanning the earnings announcement.

Although individual stocks are more susceptible to idiosyncratic risks, economic events that could impact the whole market could also affect diversified fund shares like ETFs (exchange traded funds).

Lastly, it is worth noting that Vega only affects an option's extrinsic value. All things held equal, Vega does not affect an ITM option's moneyness or intrinsic value. Vega's effect on extrinsic value contributes to why options become more expensive during periods of uncertainty.