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In options trading, vega represents the amount option prices are expected to change in response to a change in the underlying asset’s implied volatility.

More specifically, vega measures how much in value an option’s contract should change in reaction to a 1% change in the underlying asset’s implied volatility. Note that implied volatility is not the same thing as historical volatility.

Historical volatility measures a stock’s price fluctuations over time, for example, a year. Essentially, implied volatility is what the market thinks a stock’s historical volatility will be in the future, based on price changes in an option.

Option prices typically change when a company is about to announce news, such as its earnings. Traders expect that news to affect the value of the company’s stock prices. So the news will also change the value of options that use the company’s stock as its underlying asset.

For example, say an option has a value of $5 and a vega of .10. Reports emerge that the company whose stock represents the option’s underlying asset had a good year. The implied volatility of the underlying asset increases 1%. In response, the option should be expected to increase in value to $5.10.

An increase in implied volatility usually indicates that the underlying stock has a potential increase in its range of movement. Options with longer terms will have a higher vega.

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