Options trading part 5: Vega/Volatility risk

Vega, commonly known as the “volatility” of an option contract, is our fourth risk consideration while trading options & delta-hedging.

Vega is the options greek that measures the sensitivity of an option’s price to a change in “implied volatility”.

In the same way, as option contract values are impacted by changes in the underlying price (“delta”) and the passage of time (“time decay/“theta”), they are also affected by changes in the underlying contract’s volatility.

Disclaimer:

You have learned in school, on television, or on YouTube how to visualize atoms, protons, neutrons, electrons, etc.

This model is entirely inaccurate, yet we use it because it helps us visualize the specifics of these abstract subjects.

Consider everything in this article to be an oversimplification to assist you with more advanced reading about options trading

Volatility model

The price of an option depends on

• the underlying asset’s price
• the strike price
• the time to expiration
• volatility
• interest rates.

Professional options traders, hedge funds, market makers, dealers, quant firms, etc have pricing models to value option contracts.