What is ‘Vega Neutral’
A method of managing risk in options trading by establishing a hedge against the implied volatility of the underlying asset. A vega neutral option position will be not be sensitive to volatility fluctuations. These strategies are used to hedge against the risks of price sensitivity, second-order time price sensitivity and time sensitivity, respectively.
Explaining ‘Vega Neutral’
A vega neutral portfolio is still subject to risk. For example, in a portfolio of options maturing at different times, changes in volatility over time can dramatically affect total returns, making the portfolio sensitive to time vega. Furthermore, if the assumptions used to establish a position turn out to be incorrect, a position that is intended to be neutral can actually be risky. Vega is one of the “options Greeks” along with delta, gamma, rho and theta. These are used to measure different types of risk in options portfolios. Other options risk-management positions include delta neutral, gamma neutral and theta neutral.
Further Reading
- The Price of the Smirk: Returns to Delta and Vega Neutral Portfolios of S&P 500 Futures Options – papers.ssrn.com [PDF]
- Does risk-neutral skewness predict the cross section of equity option portfolio returns? – www.jstor.org [PDF]
- Hedging efficiency in the Greek options market before and after the financial crisis of 2008 – www.sciencedirect.com [PDF]
- Returns to trading portfolios of FTSE 100 index options – www.tandfonline.com [PDF]
- Delta-hedging vega risk? – www.tandfonline.com [PDF]
- Computations of price sensitivities after a financial market crash – link.springer.com [PDF]
- Computations of Price Sensitivities after a Financial Market Crash. – search.ebscohost.com [PDF]
- Do energy prices respond to US macroeconomic news? A test of the hypothesis of predetermined energy prices – www.mitpressjournals.org [PDF]
