Former eight-division world champion Pacquiao, 37, had announced his retirement after beating Timothy Bradley in April.
But his promoter Bob Arum said last month that the Filipino boxer would fight again this year.
"Retirement doesn't suit Manny right now," Pacquiao's manager Michael Koncz told the Los Angeles Times."Boxing is in his blood. When he trains, it's like a pressure-release valve. You can see a dramatic difference in his mood... he's happy.
"It's amazing what training and fighting does for him."
Pacquiao and his team will meet on 10 August in Manila to discuss whether the bout against 27-year-old Vargas should be staged in Los Angeles or Dubai.
"That's the essence of the meeting," Koncz added. "Not choosing the opponent. That's already been done."
Pacquiao's unanimous decision win over Bradley was his first fight in nearly a year, following his much-publicised defeat by Floyd Mayweather.
He had said he was ending his boxing career to concentrate on politics. Pacquiao won election to the Philippines' senate in May.
Vargas won his belt in March against compatriot Sadam Ali and has won 10 of his bouts via a knockout or stoppage, with his only defeat coming in a points loss against Bradley last year.
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