So I’ve done a few posts on the different types of Greeks option traders are exposed to. Delta, Beta, and Theta are all really important for people to consider when making a trade, but there are other Greeks that we should look at as well.
This is just a quick recap on all the Greeks, what they mean and how we can use them to our advantage.
- Delta = Direction
Delta is the rate of change in option price given a $1 movement in underlying price. So if we had a call priced at $1.75 with a delta of 0.25, a $1 increase in the underlying’s price will move the call option up 0.25, or to $2. Delta ALSO measure the probability of the option expiring in the money. So, using our 0.25 example, that represents a 25% chance that the option will expire ITM. Finally, delta can be used as a hedging tool. If we are long 100 deltas, we can sell 30 deltas against that to hedge our risk to 70 deltas.
2. Gamma = Acceleration
Gamma represents the rate of change in DELTA given a $1 move in the underlying’s price. So say we had a call with a delta of 0.25, and a price of 0.10 gamma. The underlying moves up $1, which translates to a 0.10 move in delta to 0.35. This movement increases the closer that we get to expiration, which means that we can see delta move quite rapidly.
3. Theta = Time
Theta is the rate of decay of an option price with the passage of time. The option drops in value by the amount that theta is each day. So if the call option is priced at $2, and theta is 0.05, the call price drops to $1.95 the next day. Option sellers are fans of theta decay because they want the option to decrease so they can buy it back at a cheaper price than which they sold it at. Conversely, buyers want the option to increase in price so they can sell it back for a more expensive price than what they bought it at.
4. Vega = Volatility
This is the rate of change of an option given a 1% move in implied volatility. So take that same call, priced at $2, with a 0.2 vega, and a 1% up move in IV – the call increases to $2.20. All our options add up to our total vega exposure, so we have to be careful to balance it out, especially in volatile environments.
The Greeks are bit confusing, but they are extremely important to be aware of. Delta is definitely the one that I pay attention to the most, just because it is an easy way to determine the overall directional risk. Overall, just pay attention and make sure that you’re placing trades that take advantage of this information. That way, your portfolio won’t turn into a Greek tragedy! 🙂
Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.