To capitalize on this selloff and pocket some money upfront while its implied volatility is around 31%, we'll buy some 43 calls expiring three weeks from now at a price of $1.64, but we'll also sell some 42 calls also expiring three weeks from now at a price of $2.25 apiece. Let's assume Wells Fargo (WFC) is likely to continue falling from its current price of $43.45. If vega is high at the selling point and low at the buying point - regardless of the sequence of those two transactions - that trader has squeezed out a bit more profit than he or she would have just from making the right directional call on a stock.Īs is always the case, an example will help illustrate the idea. That is to say, they're hoping to sell high and then buy low to close out that spread trade. Ideally, you're buying those options when volatility is in check, as that's when option premiums tend to be a bit lower than usual.Ĭredit spread traders looking to collect cash upfront for being a net seller of options (buying one contract, but selling another similar contract at a higher price) are often "selling volatility," perhaps without even knowing it. When you're selling volatility, it just means you're selling options at highly inflated prices due to upticks in volatility. Where vega can really start to help, however, is when fans of option spreads are choosing trades.Įver heard the term "selling volatility?" The underlying idea is simple enough. One of them is, while you can't necessarily predict changes in how volatility may change, you actually can make reasonably educated guesses as to when extremely volatile stocks are apt to settle down, and when oddly tame stocks are due for some explosive action. There's actually a lot of nuanced value in understanding what vega is and how it works, for a couple of reasons. But, in that you can't really predict increases or decreases in volatility, what good is knowing vega? It works just the same for puts and calls.įine.
Assuming nothing else has changed, that $6.00 option contract is now worth $7.00. The math is simple: 10 additional volatility points x 0.10 = $1.00. 10, if the volatility cranks up to 25, then the option's value ratchets up to $7.00, or $700 per contract. Here's an example: If an option is priced at 6.00 (or $600 per contract), its implied volatility level 15 and vega is. More specifically, it's the presumed change in the option's price for a one-point change in a stock's implied volatility. The broad definition of vega is a measure of an option's sensitivity to implied volatility. Namely, spread traders (credit as well as debit) can squeeze out a few more profit points or save some money by paying a bit more attention to vega.īut, first things first. Of those three though, the second one - vega - is worth keeping tabs on for a certain subset of options traders. Those two data nuggets can keep you too busy to worry about the lesser-watched greeks like gamma, vega, and rho. which quantify (respectively) responsiveness to changes in the price of a stock or index and the amount of value an option loses each day solely due to the passage of time.
If you're like most new options traders, you probably don't worry too much about the predictive pricing measures called "the greeks." And, if you're like veteran options traders, odds are good you're mostly focused on delta and theta.