What is 'Vega Neutral'

Vega neutral is a method of managing risk in options trading by establishing a hedge against the implied volatility of the underlying asset. Vega is one of the options Greeks along with delta, gamma, rho and theta. Vega is the Greek that corresponds with the Black-Scholes price factor for volatility, but it represents the sensitivity of the price of an option to volatility and not volatility itself. An options trader will use a vega neutral strategy when he believes that volatility presents a risk to the profits.

BREAKING DOWN 'Vega Neutral'

Vega neutral is not as popular as the neutral positions for the other Greeks. Vega essentially tells traders how a 1% change in the implied volatility (IV) of an option affects the price. So vega is a measure of how sensitive the option premium itself is to volatility. A vega neutral position is a way for options traders to remove that sensitivity from their calculations. If a position is vega neutral, it doesn't make or lose money when the implied volatility changes.

Building a Vega Neutral Portfolio

The vega of a single position is displayed on all the major trading platforms. To calculate the vega of an options portfolio, you simply sum up the vegas of all the positions. The vega on short positions should be subtracted by the vega on long positions (all weighted by the lots). In a vega neutral portfolio, total vega of all the positions will be zero. For example, if an options trader has 100 lots of $100 strike calls that have a vega of $10 each, the trader will look to short the same underlying product to eliminate $1000 worth of vega — say 200 lots of $110 strike calls with a vega of $5.

This is oversimplifying it, however, as it doesn't take into account different expirations or any other complexities. In fact, if the the options have different expiry dates, it becomes difficult to achieve true vega neutrality because implied volatility will generally not move by the same amount in options with different terms. The implied volatility term structure shows that most options have a fluctuating IV depending on the expiration month. To deal with the expiration issue, a time-weighted vega can be used with the caveat that it is making a big assumption in that the IV is mainly influenced by the time to expiry. Similarly, if a trader is seeking to create a vega neutral position with options on different underlying products, they have to be very confident in the degree of correlation between the two underlying products’ IV.  

Vega neutral strategies are usually attempting to profit from the bid-ask spread in implied volatility or the skew between the implied volatility in puts and calls. That said, vega neutral is more often used in combination with other Greeks, as in a delta neutral/vega neutral trade or a long gamma/vega neutral trade.

RELATED TERMS
  1. Vega

    Vega is a measurement of an option's sensitivity to changes in ...
  2. Gamma Neutral

    Gamma neutral hedging is an option risk management technique ...
  3. Neutral

    Neutral describes a position taken in a market that is neither ...
  4. DvegaDtime

    The rate at which the vega of an option or warrant will change ...
  5. Equity Market Neutral

    Equity market neutral is a fund strategy that creates a hedge ...
  6. Calendar Spread

    A calendar spread is a low-risk, directionally neutral options ...
Related Articles
  1. Personal Finance

    How Much Money Do You Need to Live in Las Vegas?

    Learn how much it costs to live in Las Vegas and how that amount varies based on whether you are a student, a professional or an unemployed job-seeker.
  2. Insights

    3 Main Reasons Las Vegas Sports Teams Keep Folding

    Learn why a unique labor force, competition for entertainment dollars and the stigma of gambling have kept professional sports out of Las Vegas.
  3. Trading

    Profiting From Position-Delta Neutral Trading

    This trading strategy will show you how to gain from a decline in implied volatility.
  4. Trading

    Options Greeks

    Get to know the essential risk measures and profit/loss guideposts in options strategies.
  5. Trading

    Option Greeks: The 4 Factors to Measuring Risks

    In this article, we'll look at Greek risk measures: delta, theta, vega, gamma and explain their importance that will help you better understand the Greeks.
  6. Personal Finance

    The Cheapest Times To Fly To Las Vegas

    Ways to tilt the odds in your favor. One hint: Hot weather, cool prices.
  7. Trading

    An Option Strategy for Trading Market Bottoms

    A reverse calendar spread offers a low-risk trading setup with profit potential in both directions.
  8. Trading

    Using the "Greeks" to Understand Options

    The Greeks provide a way to measure the sensitivity of an option's price to quantifiable factors.
RELATED FAQS
  1. What is the relationship between implied volatility and the volatility skew?

    Learn what the relationship is between implied volatility and the volatility skew, and see how implied volatility impacts ... Read Answer >>
  2. What are common delta hedging strategies?

    Learn about common delta hedging strategies, including how to make a position in options delta neutral by offsetting risk ... Read Answer >>
Trading Center