Kappa (Option Pricing) - Explained
What is Kappa?
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Table of ContentsWhat is Kappa in Option Pricing?How Does Kappa Work?
What is Kappa in Option Pricing?
Kappa is a ratio that measures the effect of volatility on the price of an option. It measures how much an options price will change given the level of implied volatility, regardless of whether the underlying stocks price remains the same. Kappa holds that if the underlying investment has a 1% chance, the change in the price of the option will likely occur. Kappa is referred to as Vega in Greek and the letter V symbolizes volatility. Kappa can either be positive pr negative, given the level of change in the price of an option as a result of implied volatility.
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How Does Kappa Work?
Kappa is important to investors, it tells them how much impact a change in volatility will affect an options value or price. Kappa also refers to the change in the premium that an investor paid for an option for every 1% change in the implied volatility of the underlying asset. Individual options have a Kappa, while a portfolio comprising of several options or securities has a net kappa (which is realized by summing up the kappas of each position). When a long option has a positive kappa, it means the option increases in value as the implied volatility increases. Negative kappa, on the other hand, is attributed to a short option and means that the option increases in value as the implied volatility reduces.