Time / Diagonal Spreads

Vega values for calls and the corresponding puts

The chart below shows the vega values for calls and the corresponding puts. As you can see, these values match up in every instance.

Vega can also be used to calculate how much a specific option’s price will change with a movement in implied volatility. You simply count how many volatility ticks implied volatility has moved.

Multiply that number times the vega and either add it (if volatility increased) to the option’s present value or subtract it (if volatility decreased) from the option’s present value to obtain the option’s new value under the new volatility assumption. The calculation works on individual options and can be used to calculate the value of the time spread.

Now, let’s apply the concepts of vega to the Time Spread.

When you apply the vega concept to time spreads, you observe that as implied volatility increases, the value of the time spread increases. This is because the out-month option, with the higher vega will increase more than the closer month option with the lower vega. That widens or increases the spread.

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