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GREEKS - VEGA: Volatility impact on option premiums.

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The dollar value impact on a Portfolio of a change in volatility is referred to as “Vega”.

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Vega is usually measured as the expected change in the value of a Portfolio for a 1% change in volatility. It is also usually expressed as an actual dollar number.

   

The examples below calculate the impact on option premiums of a change in Volatility. Once the impact is calculated, the change in option premiums is scaled to a 1% change in Volatility to calculate the Vega of each premium.

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We compare two scenarios where the only difference in Expected Future Stock Prices is their dispersion.

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Note how everything else equal, a higher dispersion (e.g.  Volatility) with the same Stock price  increases the premiums of both Put and Call options.

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CALCULATING VEGA:

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The Examples above calculate the prices of a Call and a Put at a different Volatility.

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In the High Volatility scenario the average up or down move is $30, and the average premium is $15.

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In the Low Volatility scenario the average up or down move is $15, and the average premium is $7.5.

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Since in both cases the initial Stock Price is 100, the High Volatility scenario corresponds to a 30% Volatility; The Low Volatility scenario corresponds to a 15% Volatility.

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For the options in the examples above, the results of a 15% change in volatility correspond to a $7.5 change in premium.

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The examples illustrate the impact of volatility on option premiums. At a higher volatility, the same options are worth more. We can also use the numbers obtained to calculate Vega, defined as the dollar impact of a 1% change in volatility.

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The Examples use a 15% change of Volatility to calculate different option premiums. We can obtain Vega by dividing by 15 the change in option premiums.

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The resulting Vega of each of each of the options is $0.50, the dollar impact of a 1% change in volatility. It is calculated by re-scaling from 15% to 1% the the impact in premium changes as a result of volatility changes  ($7.5 change in premium divided by 15 - for 15% change in volatility from 15% to 30%).

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