Using “The Greeks” To Understand Options

By | May 5, 2018

If you’re an options trader, you may have heard about “Greeks” but you may not know exactly what they are or what they can do for you.

 

What are Greeks anyway?

Greeks, including Delta, Gamma, Theta, Vega and Rho, measure the different factors that affect the price of an option contract. Since there are a variety of market factors that can affect the price of an option in some way, assuming all other factors remain unchanged, we can use these pricing models to calculate the Greeks and determine the impact of each factor when its value changes. For example, if we know that an option typically moves less than the underlying stock, we can use Delta to determine how much it is expected to move when the stock moves $1. If we know that an option loses value over time, we can use Theta to approximate how much value it loses each day.

Now, let’s define each Greek in more detail.

 

 

Delta
Delta is the change in premium over change in the underlying. If a stock or future moves 1, the call or put 1.50, the delta is .50.Mastery of Delta  is crucial for options traders.The Delta can be summed up as a representation of the rate of change in the option premium.

Out of the money: Delta approaches 0

At the money: Delta .50

In the money: Delta approaches 1.0

 

Nifty is trading at 10600 so

  1. 10500 CE will be in the money Option
  2. 10600 CE will be at the Money
  3. 10700/10800 CE will be Out of Money Option

Delta for ITM options will be 1, so if Nifty move 50 points Option should also move 50 Points

Delta for ATM options will be .5, so if Nifty move 50 points Option should also move 25 Points

Delta for OTM options will be .1-.2 and it approached 0 as we are near expiry, so if Nifty move 50 points Option should also move 5-10 points or even less if expiry is near.

 

Gamma
Gamma is the change in delta over change in the underlying. If a stock or future moves 1, the delta is .05, the gamma is .05.For a given change in the underlying, what will be the corresponding change in the delta of the option. So if you want to find the change in Delta of Option we need to find Gamma of that Option.

Rho
Rho is the change in option price over change in the risk-free interest rate. For Europeans (non-dividend options), as rates increase, call values increase; put values decrease.

Theta
Theta is rate of option decay, day to day, all other things being equal. The Theta accelerates near expiration.

Vega
Vega shows how much an option price changes per 1% change in volatility. If volatility changes by 1% and the option changes by .20, vega is .20.

 

Conclusions

There are a limitless array of possible option trading strategies and we have only briefly examined “Delta.” Never lose sight of the fact that options are multi-dimensional. They are usually not only “directional plays” that involve the simple purchase of an option as you would purchase a share of IBM.

Options can be traded from the view of many dimensions, one dimension or a pre-specified combination of dimensions. However, no matter which angle you trade off, all factors will most likely affect your trading success. These many facets of an option are never static and a change in one will quickly change another.

Above all the options trader should remember that nothing can stop the passage of time.

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