What is Vega? Managing Implied Volatility Exposure

Vega measures an option's price sensitivity to changes in implied volatility. Discover how to model volatility shocks and the 'Vega-drift' in long-dated options.

I analyzed the VIX spike of August 2024 to understand why Vega ($\nu$) is the primary driver of P&L for long-dated 'LEAPS'. Vega measures the change in an option's price for a 1% change in implied volatility: $\nu = \frac{\partial V}{\partial \sigma}$.

Unlike the other Greeks, Vega is not a derivative of the underlying price or time, but of the model's 'volatility' parameter. Both calls and puts have positive Vega. When the market panics and implied volatility increases, all options (ceteris paribus) become more expensive.

Vega is highest for at-the-money options and increases with time to expiration. A 1% move in volatility has a much larger dollar impact on a 2-year option than a 2-day option. Quants who sell volatility without a 'Vega-stop' risk being liquidated during a 'vol-mageddon' event where prices may not move, but the cost of insurance (IV) doubles.

Simulate a 'Vol Crush' after an earnings announcement by reducing $\sigma$ by 20% and calculating the resulting Vega-driven P&L.