If you dig deep down into
your high school memories,
you can probably uncover some
facts about Greek mythology.
Like Zeus, the ruler of
Olympus and all the gods.
Hades, lord of the underworld.
And all those other
guys in between.
Well, those memories
aren't so clear anymore.
But don't worry, today we'll
focus on a different group
of Greeks--
the options Greeks.
Like the ancient
gods, these Greeks
oversee certain domains--
including price, time,
and implied volatility.
The Greeks are an important
part of options trading,
as they tell you how
changes in certain factors
may impact an options price.
So let's get to know them.
We'll start with Delta.
Like Zeus, Delta is the ruler
over all the other options
Greeks, as it often has the
biggest impact on an options
value.
Delta's domain is price.
It identifies how much the
options premium may change
if the underlying
price changes $1.00.
This means that an option with a
Delta of 0.40 would be expected
to increase by $0.40 if
the underlying rose $1.00.
Delta has another
important use as well.
Some traders might use it to
estimate an options probability
of expiring in the money.
For example, an option with
a Delta of 0.40 can also be
interpreted as having a
40% chance of expiring
in the money.
The lower the Delta,
the lower the odds
that the option will
expire in the money.
One important thing
to note about Delta
is that it doesn't have a
constant rate of change.
It grows as an option
moves further in the money,
and shrinks as it moves
further out of the money.
To understand how this works,
let's look at the next Greek--
Gamma.
Gamma is Delta's Hermes--
his right hand man
in the price domain.
Gamma measures Delta's
expected rate of change.
If an option has a Delta of
0.40, and a Gamma of 0.05,
the premium we expect
it to change, $0.40,
with the first dollar
move in the underlying.
Then, to figure out the impact
of the next dollar move,
simply add Delta
and Gamma together
to find the new Delta--
0.45.
Let's move on to Theta,
the Greek of time decay.
Theta estimates how
much value slips away
from an option with
each passing day.
If an option has a
Theta of negative 0.04,
it would be expected to lose
$0.04 of value every day.
Remember, time decay works
against buyers and for sellers.
Finally, there is Vega, whose
domain is implied volatility.
Vega estimates how
much the premium
may change with each one
percentage point change
in implied volatility.
If an option has a
Vega 0.03, and implied
volatility decreases
one percentage point,
the premium will be
expected to drop $0.03.
There are a lot of
factors that could cause
a spike in implied volatility--
earning announcements, political
conditions, and even weather.
Depending on the strategy you
choose, a spike in volatility
could be a blessing, a curse,
or have a very small impact.
And the further out
an option's expiration
is, the higher its Vega will be.
In other words, options
with a longer expiration
may react more to a
change in the volatility.
Now, let's talk about the little
brother of the options Greeks--
RHO.
RHO identifies how much
an options premium may
move if interest rates change.
Because rates
change slowly, they
have a smaller impact
on options trading.
Like all little
siblings, though, RHO
is often left out of the
discussion about Greeks.
Nonetheless, RHO is
still part of the family,
so he's worth mentioning here.
Now, let's pull our
Greek council together,
and look at how they can be used
to analyze the sensitivities
of a single option.
To set the stage, let's say
your options premium is $1.30,
and your option has a Delta
of 0.35, a Gamma of 0.06,
Theta of 0.02, and Vega of 0.07.
Today, price moves
from $45 to $46,
and the premium
increases $0.35 to $1.65.
Because a day has
passed, the premium
decreases $0.02 due to Theta.
Tomorrow, price moves
from $46 to $47.
The premium increases
$0.41 to $2.04.
This is Delta plus Gamma.
Also, another day gone by means
another day of time decay,
and another $0.02
down the drain.
Implied volatility rises
one percentage point,
increasing the premium
by $0.07 to $2.09.
Putting all these
factors together
shows how a relatively small
change in the underlying
could lead to a pretty
significant change
in the options premium.
The option Greeks are
a helpful crew to know.
They help you understand the
impact various factors can
have on options trades.
You'll get to know them
very well as you continue
your options education.
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