Why Vega Hedging Matters Before Option Expiry
Summary
Vega hedging controls exposure to changes in implied volatility while options remain open. A market maker who delta and gamma hedges may still face mark-to-market gains or losses as implied volatility changes, and volatility shifts can also alter delta and gamma exposures through higher-order sensitivities. The discussion frames hedging as a choice among risk factors rather than a single fixed procedure.
At expiry, an option’s payoff depends on the underlying price and strike, so a change in implied volatility does not directly change that final payoff. Before expiry, however, volatility affects the option’s marked value, margin needs, and the economics of trading to manage gamma; those trades can realize gains or losses associated with vega. The answers offer broad guidance rather than a worked hedge or quantitative example, and the appropriate balance depends on strategy, time to maturity, and the cost and feasibility of rebalancing.
Key ideas
- Vega measures sensitivity to implied volatility and can remain significant after delta and gamma are hedged.
- Implied volatility changes affect an option’s mark-to-market value before expiry.
- At expiry, the option payoff depends on the underlying price and strike rather than implied volatility.
- Volatility shifts can change delta and gamma exposures, complicating a hedge.
- The need and method for vega hedging depend on strategy and time to maturity.
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Full text
# Purpose of Vega Hedging # Purpose of Vega Hedging I am trying to understand the principle of vega hedging. When should a market maker vega hedge his position ? Let's suppose that a market maker delta and gamma hedge himself, and carries his position (combination of Calls, Puts, Underlying) until maturity: does a change in volatility affects his P&L at maturity ? Thanks in advance ## Answer by Arshdeep (score 4) https://quant.stackexchange.com/a/78916 Doing away with jargon for a bit, it is wise to hedge every risk factor present in your portfolio. Implied vol is one of them, just like the spot. ## Answer by Gilberto (score 1) https://quant.stackexchange.com/a/78909 It depends on the strategy. The position seller suffers a lot from vega. He can try to balance the portfolio but it unbalances the delta gamma hedge. It also depends on the time until maturity. If you are far away, gamma doesn't matter much, but delta and vega do. In practice, it is easier to roll over the position than to try to balance without purchasing the asset. ## Answer by Newquant (score 1) https://quant.stackexchange.com/a/79638 No, changes in implied volatility do not affect the PnL at maturity because at maturity his option positions collapse to the terminal payoff [s-k]+, and his futures positions will settle. Vega is only important for the mark-to-market risk of the option position over it's life. This is important for margining considerations. The change in IV will also affect the delta (vanna) and gamma (volga) positions, and so assuming he is hedging deltas marked at implied volatility (the volatility minimising hedge). This m2m is also very important because as he has to trade in/out of option positions to manage his gamma position, he will crystalise the PnL that has arisen because of vega.
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