Saturday, June 16, 2012

What does it mean to be Long Vega?

The long call and the long put have positive Vega (are long volatility) and the short call and short put positions have a negative Vega (are short volatility).

The terms long and short here refer to the same relationship pattern when speaking of being long or short a stock or an option. That is, if volatility rises and you are short volatility, you will experience losses, and if volatility falls, you will have immediate unrealized gains. Likewise, if you are long volatility when implied volatility rises, you will experience unrealized gains, while if it falls, losses will be the result.

When you own a call or a put (meaning you bought the option) and volatility declines, the price of the option will decline. This is clearly not beneficial and results in a loss for long calls and puts. On the other hand, short call and short put traders would experience a gain from the decline in volatility. 

Volatility will have an immediate impact, and the size of the price decline or gains will depend on the size of Vega. So far we have only spoken of the sign (negative or positive), but the magnitude of Vega will determine the amount of gain and loss. 

Here is a wonderful article below are the highlights from this article.

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