CandleFocus Glossary Editor
Vega Neutral is a risk management method used by options traders to hedge against the implied volatility of the underlying asset. Vega neutral strategies can be used when the trader believes there is a risk to the potential profits due to movements in market volatility.
Vega is a measure of an option's price sensitivity as a result of changes in the implied volatility for the underlying stock or index. It is not the implied volatility itself but instead represents the rate of change of the options’s price relative to changes in the implied volatility. This is one of the five "options Greeks" that options traders use to calculate price movements in options and the underlying asset, along with delta, gamma, rho, and theta.
A Vega neutral strategy involves buying and selling equal quantities of options which have equal but opposite sensitivities to volatility. Typically, these strategies involve at-the-money (ATM), near-the-money (NTM) and out-of-the-money (OTM) options. A Vega neutral strategy is said to be executed when the vega of the long options is fully offset by the vega of the short options.
For example, a trader may buy one ATM call option, and sell two OTM call options and one NTM call option. This would create a Vega neutral position, as the ATM option has a greater vega value than the two OTM options, and the difference is made up by the NTM option. Thus, the total vega of the position is zero.
Traders may opt for a Vega neutral strategy when they want to neutralize their vega exposure, or when they are uncertain about the direction of market volatility. Due to the offsetting of opposing option sensitivities, Vega neutral strategies provide protection to the trader against vega risk. It is important to note, however, that Vega neutral strategies do not guarantee a profit. In fact, such strategies are reactive by nature and do not speculate on future market conditions.
Vega is a measure of an option's price sensitivity as a result of changes in the implied volatility for the underlying stock or index. It is not the implied volatility itself but instead represents the rate of change of the options’s price relative to changes in the implied volatility. This is one of the five "options Greeks" that options traders use to calculate price movements in options and the underlying asset, along with delta, gamma, rho, and theta.
A Vega neutral strategy involves buying and selling equal quantities of options which have equal but opposite sensitivities to volatility. Typically, these strategies involve at-the-money (ATM), near-the-money (NTM) and out-of-the-money (OTM) options. A Vega neutral strategy is said to be executed when the vega of the long options is fully offset by the vega of the short options.
For example, a trader may buy one ATM call option, and sell two OTM call options and one NTM call option. This would create a Vega neutral position, as the ATM option has a greater vega value than the two OTM options, and the difference is made up by the NTM option. Thus, the total vega of the position is zero.
Traders may opt for a Vega neutral strategy when they want to neutralize their vega exposure, or when they are uncertain about the direction of market volatility. Due to the offsetting of opposing option sensitivities, Vega neutral strategies provide protection to the trader against vega risk. It is important to note, however, that Vega neutral strategies do not guarantee a profit. In fact, such strategies are reactive by nature and do not speculate on future market conditions.