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Saturday, February 25, 2012

Behaviour of VEGA in relation to TIME REMAINING TO EXPIRATION – With Past DATA and CHARTS

The following is the behavior of Vega in relation to Time to Expiration:

Assuming all other things unchanged, Vega decreases as the option gets nearer to expiration.

We’ll use the same past actual data as shown in the previous post on the behavior of Delta, namely:
Options Chain for Call options of RIMM as at 3 Sep 2010, when the closing price is $44.78 and Implied Volatility (IV) is 54.05, for expiration month of Sep 2010 (10 days to expiration), October 2010 (38 days to expiration) and Dec 2010 (101 days to expiration).

The summary of Vega values for different Time to Expiration:


As can be seen from the table, for all level of moneyness (ITM, ATM, OTM), Vega values are always lower for the options with expiration month “Sep-10” (nearer to expiration), followed by “Oct-10”, and then “Dec-10” (further to expiration).
This proves the statement above.

Now, let’s move on to compare Vega of different time to expiration at various strike prices.



As can be seen in the chart:

For all the three options with different time to expiration, Vega always behaves the same way, i.e. Vega of ATM options is always higher than deeper ITM and OTM options.

Comparing the Vega values between deeper ITM and OTM options given the same time to expiration, OTM option seem to have higher Vega than ITM option.

This makes sense because ATM options have the highest time value component, and changes in Implied Volatility (IV) would only affect the time value portion of an option’s price.Comparing between ITM & OTM options, volatility changes would have greater effect for OTM options than for ITM options. This because OTM options comprise merely of time value, while ITM options comprise of intrinsic value plus time value. The deeper the ITM options, the smaller the portion of time value the ITM option would have.

To view the list of all the series on the this topic, please refer to:
Behaviour of OPTION GREEKS in relation to TIME REMAINING TO EXPIRATION and IMPLIED VOLATILITY (IV) – With Past DATA and CHARTS.

Other Learning Resources:
* FREE Trading Educational Videos with Special Feature
* FREE Trading Educational Videos from Trading Experts

Related Topics:
* Understanding Implied Volatility (IV)
* Understanding Option Greek
* Understanding Option’s Time Value
* Learning Candlestick Charts
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2