Using Vega to Relate Option Quote Spreads to Volatility

Summary

The document explains a rule of thumb that relates an option's bid-ask spread to its vega. Vega measures how much the option price changes when implied volatility changes. Because of that sensitivity, a volatility bid-ask interval can be translated into a price interval by multiplying the volatility difference by vega. The quoted price spread can therefore be understood as reflecting quotes at different volatility levels.

The response also gives a risk-based intuition: options with prices that vary more may require wider spreads in dollar terms. This offers a way to interpret or compare option market quotes, but the discussion is brief and does not derive a universal spread formula. It provides no empirical evidence that spreads should always equal vega, nor does it account for factors such as liquidity, inventory, hedging costs, or market conditions. The example in the question is illustrative; the main lesson is the link between volatility quoting and price sensitivity, rather than a fixed competitiveness threshold.

Key ideas

• Vega measures an option price's sensitivity to implied volatility.
• Multiplying vega by a volatility quote interval converts that interval into an approximate price spread.
• Options with greater price variation may need wider dollar spreads to compensate for risk.
• The vega-based rule is an intuition, not a universal spread-setting formula.

Tags

# Why do options market makers make their spread as wide as the corresponding vega?


# Why do options market makers make their spread as wide as the corresponding vega?












I've heard that option market makers make their bid ask spread as wide as the vega of the contract they are quoting. If the quoted spread is narrower than the vega of the option it is said that the price is competitive. Why is this? What is the basis for the rule of thumb?

So for example, if the at the money option has A vega of 10 the corrosponding market could be 1.10 bid 1.20 ask (it is 10 cents wide).

## Answer by roz (score 1)

https://quant.stackexchange.com/a/49225

The reason vega is used like this in quoting a spread is two fold. First, vega gives the change in price with respect to a change in volatility. So when you obtain a bid ask volatility you can multiply by vega to get the bid ask in dollars. It is as if you are pricing two different options, one with a lower vol and one with a higher vol.

The second reason is intuitively obvious. The spread is made wider for options whose prices have higher variation. So options need to have a corresponding spread in dollar terms to account for this risk.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.