Imagine, Reliance industries is trading at ₹2000, trader A buys a Call Option with a strike price of ₹2000 for say ₹30 with 15 days to expiry. The stock generally moves around ₹20 a day, the market isn’t expecting big price swings.
Five days before the expiry, Reliance Industries suddenly jumps by ₹50. This spike in movement increased the probability of the option ending In-the-Money. As a result, the value of the Call Option goes up to ₹55
If a stock usually moves up or down by ₹20 in a day, that’s what we expect as its normal behaviour, or regular volatility. But if one day it suddenly jumps or drops by ₹50, that’s an unexpected surge in movement — a volatility spike!
This is where Vega comes in, it shows how much an option’s price changes with a change in the volatility. In this case, higher volatility benefits the long Call position.
A sudden increase in volatility is always positive for the trader who has bought a call or put option, while it is negative for someone who has sold options.
Disclaimer:
This information is for educational purposes only. Trading in Futures and Options involves substantial risk and is unsuitable for all investors. Past performance is not indicative of future results. Consult a financial advisor before engaging in such trading activities.
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