Lesson 16 of 20 · 7 min

Vega, and why volatility crush is not a surprise

Vega measures sensitivity to implied volatility, and volatility reliably falls once uncertainty resolves.

Vega is the change in an option's price for a one-point change in implied volatility. It is not a Greek letter, which is a small permanent embarrassment of the field, but it is one of the two most important numbers on this list.

In the base case vega is $0.114 per volatility point. So if implied volatility rises from 25 to 26 percent with nothing else changing, the call should gain about eleven cents. Vega is positive for all long options, calls and puts alike, because both benefit from a wider distribution.

Vega grows with time to expiry, which is the opposite of gamma and theta. The base-case 30-day contract has vega $0.114; the 90-day contract has $0.196; the one-year contract has $0.383. That makes sense — a volatility change applies to the whole remaining life, so a longer life means more of it to apply to. Long-dated contracts are volatility instruments far more than they are direction instruments.

Now the crush. Before a scheduled event — an earnings report, a decision, a data release — implied volatility on near-dated contracts is elevated, because the outcome is unknown. When the event happens, the uncertainty is gone whether the news was good or bad. Implied volatility falls, and every contract loses its vega multiplied by the size of that fall.

Take the base case at 10 days with implied volatility at 70 percent: the at-the-money call is worth $4.67. After the event, at 9 days and 30 percent volatility, with the underlying unchanged at 100, it is worth $1.93. That is a 59 percent loss on a day when the stock did nothing. Only one day of theta was involved; the rest is vega. This is entirely predictable in direction — the timing of the event is published — even though its size is not.

Key terms

Vega: The change in an option's price per one-point change in implied volatility. Positive for all long options.
Volatility crush: The fall in implied volatility once an uncertainty-resolving event has occurred. Predictable in direction, not in size.
Event premium: The extra extrinsic value in contracts spanning a scheduled event. It is what disappears when the event resolves.

Worked example

Vega checked, then crush measured

Underlying 100, strike 100, rate 4%. Volatility and expiry as stated.

90 days at 25%: price, vega: $5.43, $0.196
90 days at 26%: $5.63
Vega at 30 days / 90 days / 365 days: $0.114 / $0.196 / $0.383
Pre-event: 10 days at 70% volatility: $4.67
Post-event: 9 days at 30% volatility, stock unchanged: $1.93
Loss: −$2.74, or 59%

The stock did not move and the contract lost 59 percent. The event was on the calendar and so was the crush.

Check yourself

A 10-day at-the-money call is worth $4.67 at 70% implied volatility. The event passes, the stock is unchanged, and implied volatility falls to 30%. What is the contract worth, and how much of the loss is time?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.