Vega Exposure to Implied Volatility Changes

Vega measures how much an option's price changes when implied volatility (IV) moves by one percentage point. Unlike delta and gamma, which relate to the underlying's price, vega captures the impact of the market's expectations about future volatility. Managing vega is essential for strategies where volatility itself is the primary trade.

Definition and Key Concepts

What Is Vega?

Vega is the expected change in option price for a 1% change in implied volatility:

• Positive vega: Option gains value when IV rises
• Negative vega: Option gains value when IV falls

Example: A vega of $0.15 means the option gains $15 per contract when IV rises 1%.

All Options Are Long Vega

Every long option position has positive vega—both calls and puts. Buying options is a bet that actual volatility will exceed what's priced into IV, while selling options bets the opposite.

Vega and Time to Expiration

Longer-dated options have higher vega because there's more time for volatility to affect the outcome:

Vega and Moneyness

ATM options have the highest vega:

How It Works in Practice

Calculating Vega Exposure

Single Option: Vega impact = Vega × IV Change × 100 × Contracts

Example: 5 contracts with vega $0.12, IV rises 3% Impact = $0.12 × 3 × 100 × 5 = $180 gain

Portfolio Vega: Sum vega across all positions:

If IV rises 5%, this position gains $20 × 5 = $100.

Volatility Crush Example

A common vega event is the "volatility crush" after earnings.

Pre-Earnings:

• XYZ at $100
• 30-day IV: 45%
• ATM straddle price: $9.00
• Straddle vega: +$0.20 per 1% IV

Post-Earnings:

• XYZ at $102 (2% gain)
• 30-day IV: 28% (down 17%)
• Expected straddle price from vega: $9.00 - ($0.20 × 17) = $5.60

Despite the stock moving, the straddle lost value because IV crashed. The long vega position suffered from the volatility crush.

Building Vega-Neutral Positions

To isolate other Greeks, traders may neutralize vega:

Example: Long calendar spread (vega-positive) combined with short OTM options (vega-negative) to achieve net zero vega while maintaining theta income.

Worked Example

Long Vega Trade: Pre-Earnings Straddle

ABC reports earnings in 7 days. Current IV is low by historical standards.

Situation:

• ABC at $50
• Current IV: 32% (historical average before earnings: 45%)
• 14-day ATM straddle: $3.20
• Straddle vega: +$0.08

Trade:

• Buy 10 ABC $50 straddles at $3.20 ($3,200 total)
• Position vega: +$0.08 × 10 × 100 = +$80 per 1% IV

Thesis: IV should rise to 45% as earnings approach.

Scenario Analysis:

Post-Earnings Consideration: If held through earnings and ABC moves to $55:

• Straddle gains from delta: ~$500
• Straddle loses from IV crush (45% → 28%): -$80 × 17 = -$1,360
• Net: -$860 loss despite 10% stock gain

Better Approach: Sell the straddle before earnings to capture IV expansion, avoiding the post-earnings crush.

Short Vega Trade: Iron Condor

SPY at $450 after a volatility spike. IV is elevated.

Situation:

• SPY at $450
• Current IV: 28% (typically 16-18%)
• Expecting IV to normalize

Trade:

• Sell $440/$435 put spread for $1.20
• Sell $460/$465 call spread for $1.10
• Net credit: $2.30
• Position vega: -$0.06 per 1% IV

Vega-Driven Profit: If IV drops from 28% to 18% (-10%):

• Vega gain: +$0.06 × 10 × 100 = +$60 per contract
• Plus theta decay
• Total profit accelerates from IV normalization

Risks, Limitations, and Tradeoffs

Vega Is Larger for Longer-Dated Options

A LEAPS option might have vega of $0.50 or more per 1% IV. A 10% IV move could swing the option $500 per contract—more than many would expect from time value alone.

IV Can Increase When You're Short Vega

Selling premium to collect theta also creates short vega exposure. A volatility spike (market crash, unexpected news) increases option values, creating losses for short vega positions.

Vega Doesn't Capture Skew Changes

IV varies across strikes (volatility smile/skew). Vega measures sensitivity to parallel shifts in the IV surface, not changes in skew. A steepening skew can hurt positions even if ATM IV is stable.

Term Structure Effects

IV differs across expirations. Near-term options may see IV spike while longer-dated IV remains stable. Calendar spreads are particularly sensitive to term structure changes.

Common Pitfalls

1. Ignoring vega when buying options: Long options need IV to rise or stay stable; buying when IV is elevated sets you up for crush.

2. Selling options when IV is low: Collecting premium when IV is historically low means you're short vega at the worst time.

3. Confusing realized and implied volatility: IV is a forecast; realized volatility is actual. They often diverge.

4. Underestimating post-event crush: IV can drop 30-50% after earnings, overwhelming any directional gains.

5. Not checking IV percentile: Compare current IV to its historical range before trading.

Checklist for Vega Management

• Calculate net position vega across all options
• Compare current IV to historical average (IV percentile/rank)
• Assess whether you want to be long or short volatility
• Check for upcoming events that might spike IV
• Estimate potential P/L from expected IV changes
• Consider vega along with theta—they often work in opposition
• For long vega, plan to exit before post-event crush
• For short vega, have stops or adjustments for IV spikes

Next Steps

Interest rates also affect option prices, though usually less than volatility. See Rho and Interest Rate Sensitivity for understanding this Greek.

For time decay strategies that often accompany short vega positions, review Theta Decay and Time-Based Trades.