Thursday, July 28, 2016

options - Link between Vega and Gamma



"The vega is the integral of the gamma profits ( ie expected gamma rebalancing P/L) over the duration of the option at one volatility minus the same integral at a different volatility...Mathematically, it is:


$$\text{Vega} = \sigma t S^2 \text{Gamma}$$


where $S$ is the asset price, $t$ the time left to expiration and $\sigma$ the volatility.



This is again from Dynamic Hedging by Taleb. I cannot understand the first sentence because it gives no indication of which volatilities to pick nor what the integrand of the integral would be.



Shortly after Taleb states the formula above, again no justification as to where it came from.


Please could someone explain this better.



Answer



Under the Black-Scholes model, \begin{align*} Gamma &= \frac{N'(d_1)}{S \sigma \sqrt{T-t}}\\ Vega &= SN'(d_1) \sqrt{T-t}. \end{align*} Then, it is easy to see that \begin{align*} Vega = S^2 \sigma (T-t) Gamma. \end{align*}


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