Since option prices—puts as well as calls—tend to be higher when the underlying instrument's volatility is greater, James Brumley of BigTrends.com discusses the Greek known as Vega and stresses its importance for option trading.
Though one of the more esoteric (and difficult to employ) so-called "Greeks" of option trading, Vega is a number and concept option traders should at least familiarize themselves with simply to improve their understanding of why option-pricing dynamics change over time and can change from one strike price or expiry to the next.
Simply put, Vega is a measure of the impact changes in the underlying stock's (or index's) volatility may have on that option's price. Vega is numerically expressed as the amount of price change an option may experience solely due to every 1% increment change in that stock's or index's quantifiable volatility.
Yes, it matters.
Option prices—puts as well as calls—tend to be higher when the underlying instrument's volatility is greater. Ergo, when determining a fair value or target price for an option, the current or future volatility—and any potential changes in that volatility—must be considered. To see an example and read the entire article, click here…
By James Brumley of BigTrends.com