A surfer landed on this blog when searching for the phrase: ‘What is vega neutral?’
This is not a topic that I have discussed at Options for Rookies, and this is an opportunity to do .
Definition of Vega
In simple terms, vega let’s us know how much we should expect an option’s price to change, when the implied volatility (IV) of the option changes by 1%. Note: The term ‘1%’ refers to a change in the implied volatility from 30 to either 29 or 31.
When we sum the total vega of each of the options in a given position, vega tells us how much we can anticipate earning (or losing) when IV changes by one point
Using more ‘official’ terminology: Vega measures the sensitivity of the option premium to volatility. In other words, as the volatility environment changes, the value of an option changes.
‘Option premium’ refers to the real value of the option in the marketplace and the term ‘volatility’ in this context, refers to the implied volatility of the option.
Mathematically, vega is the derivative of the option value with respect to the volatility of the underlying asset.
Most individual investors and traders tend to trade with a market bias. They are bullish or bearish; they believe that the market will be quiet (less volatile) or exciting (volatile). They construct positions that earn money when their bias becomes reality.
Most professional option traders prefer to own positions with minimal risk, they build positions that are neutral in as many respects as possible.
Delta neutral positions are neither bullish nor bearish.
Gamma neutral positions remain delta neutral as the market rises or falls.
Theta neutral positions neither make nor lose money as time passes.
A vega neutral position has a total vega near zero and offers a hedge against a change in the implied volatility of the underlying. The trader who has a market bias that she wants to play, but does not want to be exposed to a loss if the implied volatility changes, makes a trade that is vega neutral.
It is important to understand that we option traders have the ability to control risk, and being vega-neutral is one of those ways used by more sophisticated traders.
Personal note: The positions that I trade are seldom, if ever, vega neutral.