Can someone provide me an intuitive explanation for why vega is highest for options ATM and why it gets lower for options OTM and ITM. Why do deep options have lower vega than the ATM counterparts???? I read this: http://www.theoptionsguide.com/vega.aspx and Natenberg... but the explanations don't really make intuitive sense. can someone help?
Options are volatility. The ATM carries the largest premium of the extrinsic strip and therefore will carry the greatest vega as well. Each strike has one-line on IV and vega to prevent arbitrage.
ATM options are more sensitive to change. Take a 100 stock. Let's say the ATM straddle is $3.00. Now there is an expectation of higher vol, maybe from earnings coming out. Now some one expects a larger move so is willing to pay $3.50 for the straddle. The 25 delta call and put will go up in value, but not as much as the ATM. You can't expect OTM strangle on the 25 delta options to go up by $.50 too. Maybe that only goes up by $0.10. That represents the difference in vega on those options.
1) At-the-money options have the greatest extrinsic value compared to in-the-money options and out-of-the money options. 2) In order to "justify/sustain" that, the time decay sensitivity is also highest for the at-the-monies. :eek: 3) You have a tradeoff between the "shorts" wanting a stable market versus the "longs" wanting rapid price fluctuation.
This is an explanation of gamma rather than vega. In any case, OP's confusion may be because dollar-for-dollar, OTM options are more vol-sensitive than ATM options.
Right the vol will be higher for OTM because its dollar value but gamma or sensitivity to delta higher near or ATM ?
All exposures are highest for the ATM, but this doesn't relate to modality. vanna and volga may be higher, but any movement reduces the exposure of the ATM option as it's -convex, ATM. It's why shorting wings can blow you up. The exposure is nil, but leveraged.