The option's vega is a measure of the impact of changes in the underlying volatility on the option price.

With quarterly results around the corner, I thought of discussing a very oblivious yet crucial element of the Option Premium called Vega. With Option being one of the most functional vehicles of making most out of an event like result, one needs to know this.

But before we try to analyze the relationship let us define Vega.

The option's vega is a measure of the impact of changes in the underlying volatility on the option price. Specifically, the vega of an option expresses the change in the price of the option for every 1% change in implied volatility.

Here, implied volatility is nothing but the Volatility figure fed into the option pricing formula to arrive at current premium given a particular underlying price and known amount of time left.

Implied volatility is different from the realized or historical volatility of the underlying price. Reason being Implied volatility is always forward looking. It is the expected volatility figure. The reason it is important to know right now is there could be meaningful change in the implied volatility over the period up to and after the event.

But before we do that, let me share with you that relationship of implied volatility and option premium is of direct in nature. Option premiums rise with rise in Implied volatility and likewise option premiums fall with fall in implied volatility.

To bring this entire concept into perspective, lets understand what happens before the results. Expectation of an action starts building into the sentiments. This goes into the prices via a higher implied volatility figure, pushing the option premiums higher than it usually is.

Now once the event of the result is over. Whatever outcome was the unknown then is now known so the excitement dies down and so does the Implied Volatility since the action is already over. This in turn results into correction (fall) in implied volatility to its normal level pushing the option premiums down.

Remember, in the entire discussion of the above variations in implied volatility we have not brought price in picture yet.

Now, knowing Vega the figure that shows sensitivity of implied volatility to the options premium is important because right ahead of the results Implied volatility rises.

Compare that implied volatility figure with the same kind of option (similar distant strike from CMP) a month back when the event was not in site. The difference when multiplied by Vega would give you the amount of dent in the option premium that should be expected once the vent is over.

Now comes the application part of this. So the problem we are dealing here with is while being right on the directional element of the price action may work in our favor in an option buy position, the loss in option premium post result due to drop in implied volatility might wipe of part or whole of that gain.

Example is recently announced TCS results where a trade taken @1988 day before the results with 1940 Put @ 60 should have made money with drop in the price next day to 1920 right?

What ended up happening was there was a drop of more than 10% in implied volatility as a result despite the fall 1940 Put ended up @ 63, barely managing to stick the same price after adjusting for the fall in Implied Volatility.

Well solution to this problem is not that difficult but what is essential is knowing that there could be demon in the name of drop in implied volatility to take a lot of gains off of Long Option position after the event.

Now, by simply valuing the options with price objective of current scenario and plugging in implied volatility from rather calmer times would give you more accurate results of how the premium could look like if the stock were to get to your price objective after the result.

I highly recommend to do this exercise before getting into any option position amid this result season because while trading options monetizing view is equally important as monetizing the knowledge.

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