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Option Greeks Definitions, Types and Its Impact on Trading

Published on Wednesday, April 4, 2018 by Chittorgarh.com Team | Modified on Monday, February 19, 2024

What helps you cook tasty food?

Cooking skills?

The flavour of food depends largely, but not completely, on the quality of the ingredients used, the balance of the number of ingredients used, the cooking temperature, and so on. Thus, even a 5-star chef cannot prepare a tasty dish if the ingredients are not of good quality and are used in an unbalanced proportion or if he overcooks it. Similarly, success in options trading depends on many factors, not just the performance of the underlying asset. It depends on factors such as the direction of movement of the market, the speed at which it moves, the fluctuations of the market, and the time to expiry. The factors that influence options trading are known as "Option Greeks".

There are five Option Greeks:

  • Delta Options
  • Gamma Options
  • Vega Options
  • Theta Options
  • Rho Options

Each of these metrics helps the trader understand the performance of an option under certain scenarios.

For example, delta measures directional risk, while gamma measures the directional rate of change of the underlying. Vega measures the expected volatility of the underlying, while theta is a measure of the time to expiration of options. Rho measures the change in value of an option due to interest rate fluctuations.

Simply put, option Greeks help you measure the different types of risks associated with an option and then make an informed decision about your position - whether to buy, exercise your right, or abandon the position. Let's understand the individual Option Greeks in detail:

1. Delta Option Greek (Option Delta Meaning & Importance)

Option Greek delta (Δ) measures the sensitivity of the price changes of an option about the price changes of the underlying. If the price of the underlying rises, the price of the option would change by a certain amount. It measures the amount by which the price of an option changes if the value of the underlying changes by 1 point.

Deltas are expressed as decimal points. Delta on calls are expressed as positive numbers between 0 and 1, while Deltas on puts are expressed as negative numbers between 0 and -1.

In the case of a stock option, for example, it indicates how the premium price of an option changes if the value of a share changes by 1 point. Suppose you buy an Infosys Option when the stock price was Rs. 2500. After the purchase, the stock has risen to Rs. 2550. Now the price of the option will not go up by 50 points. This is where the delta of an option comes into play. It indicates how much the premium of an option increases if the underlying moves accordingly.

The delta results from ∂V/AS, where:

∂ = the first derivative

S = the price of the underlying

V = the price of the option

It is usually calculated as a decimal number from -1 to 1. Call options can have a delta of 0 to 1, and they set a delta of -1 to 0. The closer the option is to 1 t -1, the lower the cash option.

Option Greek Delta advantages

  • The delta tells you how your option position is affected by the price movements of the underlying asset.
  • It provides information about the profitability of an option position, e.g. an in-the-money option with a higher delta would bring more profit than an in-the-money option with a lower delta.
  • The delta gives you information about the probability that your option will remain in the money. A higher delta means a higher probability that your option will stay in the money, and the probability decreases the lower your delta value is.
  • For example, an option with a delta of 1.0 has a 100% chance of staying in the money, while an option with a delta of 0.25 has a 25% chance.
  • In this way, you can take calculated risks based on the delta value.

2. Gamma Option Greek (Option Greek Gamma Meaning & Importance)

Gamma (Γ) measures the potential increase or decrease in the delta of an option if the stock price changes by 1 point. Delta thus measures the price change, while gamma measures the rate of change of delta.

Gammas are expressed as a decimal point ranging from 0 to 1 and can be either negative or positive.

Long options have a positive gamma. An option has a maximum gamma when it is at the money. However, the gamma decreases when an option is deep in the money or out of the money.

Suppose the stock of ABS Co. is trading at Rs. 100. A call option with a strike price of 102 has a delta of 0.40 and a gamma of 0.03. A put option with a strike price of 97 that expires in the same month has a delta of -0.30 and a gamma of 0.02. If ABS rises by Rs. 1 to Rs. 101, the delta of the call option with strike price 102 rises to an estimated 0.43, while the delta of the put option with strike price 97 falls to an estimated –.28, assuming all other factors remain the same.

On the other hand, if the ABS falls by Rs. 1 to Rs. 99, the delta of the call option with strike price 102 is estimated to be 0.37 and the delta of the put option with strike price 97 is estimated to be –.32, assuming all other factors remain the same.

How does knowing Gamma help you as an options trader?

  • Gamma is helpful for you if you are taking short and long positions in an option contract.
  • It is also helpful in deploying advanced option strategies.

3. Option Greek Theta (Option Greek Meaning & Importance)

Time is an enemy in options trading. Options are highly dependent on their life to expiry. Theta (θ) is a measure of the loss in value of an option position due to the passage of time. It indicates how much your option loses in value over a day. Assuming an option has a premium of 10 and a theta of 0.05, it will fall to 9.95 (10-0.05) on the first day, 9.90 the next day and so on.

Theta starts practically at zero and begins to accelerate, especially in the last few weeks before the deadline.

How does knowing about theta help you as an options trader?

Theta is very helpful in applying advanced strategies, especially income strategies.

4. Vega Options Greek- (Option Greek Vega Meaning & Importance)

Vega (ν) measures the change in the option premium for each percentage change in the volatility of the underlying. Options with high volatility are traded with higher premiums than options with low volatility. Vega indicates how much the option price moves up or down when volatility fluctuates.

Assuming the underlying option has a volatility factor of 40% and the current premium is 100, a vega of 0.10 would mean that the premium increases to 100.10 if the volatility increases by 1% to 41%.

How does knowing about vega help you as an options trader?

Vega is not correlated with delta and gamma. Therefore, it is used by traders to establish option positions that are delta and gamma-neutral. With such positions, profits are dependent on the likely increase or decrease in volatility.

5. Rho Options Greek (Option Greek Rho Meaning & Importance)

Rho (ρ) measures the expected change in the value of an option for a 1 per cent change in interest rates. Rho is one of the least used measures because options are usually traded for relatively short periods and interest rates do not change often during these periods.

How does knowing Rho help you as an options trader?

As mentioned above, Rho is generally not used for trading. However, the rise in interest rates increases buy prices and decreases sell prices and vice versa.

Frequently Asked Questions

  1. 1. How to check Option Greek?

    Options Greeks are financial metrics that help traders measure the price sensitivity of option contracts. There are 5 options Greeks:

    1. Option Greek Delta: Measures the sensitivity of an option's price changes relative to the price changes of the underlying asset.
    2. Gamma Options Greek: Measures the change in delta in relation to changes in the price of the underlying.
    3. Option Greek Vega: Measures the sensitivity of the option price in relation to the volatility of the underlying.
    4. Theta Option Greeks: Measures the sensitivity of the option price in relation to the term of the option.

    Rho Option Greeks: Measures the sensitivity of the option price to rising interest rates.

     

  2. 2. How to use option greek?

    Options contracts are used to hedge a portfolio. The motive is to offset possible unfavorable developments in other investments. It is well known that options contracts are used to speculate on whether the price of an asset might rise or fall.

     

  3. 3. What does the Greek mean in options?

    The Greeks refer to a series of calculations that allow you to measure various factors that could affect the price of an options contract. With this information, you can make more informed decisions about which options to trade and when to trade them.

     

  4. 4. What is gamma in Options Greek?

    Gamma (Γ) is a measure of the change in the delta in relation to the changes in the price of the underlying. If the price of the underlying rises by 1 point, the delta of the option changes by the gamma value. The main use of gamma is to evaluate the delta of the option.

     

  5. 5. What is option greek?

    Options can be exercised and converted into shares of the underlying security at a certain price, known as the strike price. Each option has an end date, known as the expiration date, and a value associated with it, known as the premium.

    The premium of an option is usually based on an option pricing model that results in price fluctuations. They are usually considered in conjunction with an option pricing model to understand and evaluate the associated risks. This price sensitivity is measured by options greeks. There are 5 options greeks: Delta, Gamma, Vega, Theta, and Rho.

     

  6. 6. What is Vega option greek?

    Vega is a Greek option that measures the sensitivity of the option price to the volatility of the asset. If the volatility of the asset increases by one percent, the option price changes by the amount of vega. Vega is expressed as a monetary amount to one decimal place. An increase in vega generally corresponds to an increase in the option value.

     

  7. 7. What is delta option greek?

    The delta (Δ) indicates how sensitive the price of an option is to changes in the value of the underlying security. In other words, by how much does the price of the option rise or fall when the price of the security rises or falls? The delta measures how much the price of the option changes if the price of the security changes by 1 point.

    The delta of an option varies during the life of the option depending on the underlying share price and the time remaining until expiration.

     

  8. 8. What is theta option greek?

    Theta (Θ) represents the rate of decay of an option over time. In particular, it describes how much the value of an option changes each day as the expiry date approaches. Options tend to lose value as the expiry date approaches, so theta is usually a negative number.

    As the expiration date approaches, theta increases as the time remaining to make a profit on the option decreases.

     

  9. 9. What is gamma option greek?

    Gamma (Γ) represents the rate of change of the delta in relation to the change in the price of the underlying. It measures how much the delta changes when the value of the security rises or falls by 1 point.

    Investors use gamma to predict changes in the delta of an option and determine how stable the delta is. Gamma is a number between 0 and 1.00.

     

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