Vega and Implied Volatility
Option prices hide the market's expectation of future swings. Work backward from the price and you get implied volatility; how much the option price changes per 1 percentage point of it is Vega.
Risk warning: forex, CFDs, options, futures and crypto assets usually involve leverage or high volatility, and you can lose more than you put in. This lesson only teaches the concepts; all numbers are for illustration and are not investment advice.
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Text version · Advanced Option Strategies, lesson 2: “Vega and Implied Volatility”
Option prices hide the market's expectation of future swings. Work backward from the price and you get implied volatility; how much the option price changes per 1 percentage point of it is Vega.
Expectations are hidden in the price
In the option pricing formula, volatility is the only input you can't see. Plug the market price back into the formula and solve for it, and you get the implied volatility (IV): the future volatility the market is collectively betting on.
Vega: sensitivity to volatility
Vega is how much the option price changes for each 1-point move in IV. The longer the expiration and the closer to the money, the bigger the Vega: long-dated options are more sensitive to “market mood”.
Turn IV into a price range
IV is an annual number. Converted to the time until expiration: the expected move is about share price × IV × √(days left ÷ 365). With the stock at $100, IV at 32% and 30 days left, that's about ±$9.2, with roughly a 68% chance of landing in that range.
Key takeaways
- Implied volatility (IV) is the volatility backed out of an option's market price. It represents the swings the market expects.
- Vega = the change in the option price when IV rises 1 percentage point. The longer the expiration, the bigger the Vega.
- Whether an option is expensive depends on its IV, not its price.
- Expected move ≈ stock price × IV × √(days remaining ÷ 365), with about a 68% chance of landing inside it.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Drag the option price up: how high does implied volatility rise with it? Where do the blue dashed line and the yellow curve cross?
- Keep IV around 30% and switch between 30, 90 and 365 days: what's the Vega for each?
- Drag the price all the way down: how low does IV go? Is buying options now expensive or cheap?
- With 30 days left, click “Before earnings 70%”: what's the “Market's expected move” in dollars? Then click “Calm 15%”: how much does the range shrink to?
Quiz and explanations
- 1. For the same stock and strike, the option price suddenly rises while the stock hasn't moved. What's most likely?
- Answer: Implied volatility rose.The stock didn't move but the option got pricier, so the market now expects bigger swings.
- 2. Vega = 0.15 and IV rises from 30% to 34%. Roughly what happens to the option price?
- Answer: Up $0.60.4 percentage points × 0.15 = $0.60.
- 3. The stock is $100 and a 30-day option has IV = 40%. Roughly how big a move does the market expect by expiration?
- Answer: About ±$11.5.$100 × 40% × √(30 ÷ 365) ≈ $100 × 0.4 × 0.287 ≈ $11.5.
Terms in this lesson
- expected move (Expected Move): The range the market expects the stock to move by expiry, derived from implied volatility (about stock price × IV × √years left, with roughly a 68% chance of landing inside).
- implied volatility (IV) (Implied Volatility (IV)): The volatility backed out of an option's market price, reflecting the market's expectation of future swings; the higher the IV, the pricier the option.
- Vega: How much an option's price changes for each 1-point rise in implied volatility; longer-dated, at-the-money options have more Vega.