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Feb 21st | 13.35 GMT
Using 'The Greeks' For Options Trading
By CIFER | Updated Jan 25th, 2021
DELTA
Delta represents change, or in the options market - the rate of change with the options price and the underlying asset. Beginner option traders tend to assume that as the asset price increases by $1, the option will follow with perfect correlation, also moving $1. This is not necessarily the case.
For example: Apple call options have a delta of 0.7, this means for every $1 change in the stock would result in a 70 cent increase in the options price. The same principal applies if the stock were to fall $1, a delta of 0.7 would result in only a 70cent drop in option value.
Delta on call options range from: 0>1 whilst the delta on put options range from -1<0, so the partial derivative represents sensitivity of the options price to the asset.
As expiration nears, the delta for in-the-money calls will get closer to 1, showing a near perfect correlation with the asset price and option prices. On the other hand, delta on out-of-the money calls will approach 0, representing no change in options pricing even when the asset moves. At this stage, delta represents the probability of expiring in the money, for example:
Delta is 50 on an at-the-money apple call with one day to expiration, the 50 delta essentially represents a 50/50 chance the option will expire in-the-money. Therefore, options that have a 90 delta as expiration nears essentially represents on 90% probability the option will expire in the money. Although delta does not actually represent probability, its a useful method for thinking about options pricing.
Similar theory applies for puts however delta range from 0 to -1 where -1 is a perfect correlation with option pricing and stock prices.
Remember:
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Delta measures the rate of change of the options price for every $1 change in the underlying asset
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High Delta represents a close correlation with asset and option prices
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Delta ranges from 0>1 for call options and -1<0 for put options
THETA
Theta, or otherwise known as time decay is the biggest enemy for option buyers but an excellent tool for writers. All else equal, theta is measure of how much the option will depreciate on a daily basis as time passes and expiration nears; the closer option expiration becomes, theta (time decay) accelerates. Essentially, theta is a measure of risk in the option premiums paid by the investor, which will diminish over time unless the underlying asset moves faster than time decay.
At-the-money options will experience the most time decay as expiration nears than in/out-of-the-money options, this is because there is more time value still embedded in the option premium closer to expiration.
Remember:
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Theta measures decay (depreciation) in option premiums
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Decay accelerates as expiration nears
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Theta is a buyers enemy but a sellers friend
GAMMA
Gamma measures the rate that delta changes for every 1 point move in the underlying assets's price. As the first derivative of delta and second derivative of the underlying asset, gamma is used by investors to gauge how delta will move over time as asset prices change.
Typically, calculating gamma is complex to find exact figures however as a basic example let's assume a delta of 0.5, which means when the asset price rises by $1, the option value will increase by $0.50. However, then we will have a new delta as asset prices rise. So, assume the new delta has increased to 0.65, a 0.15 increase in delta, or otherwise known as Gamma.
Remember:
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Gamma is used to measure the rate of change in option's delta
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Gamma is at its highest when an option is at-the-money and at its lowest when options are far away from the money
VEGA
Vega is a partial derivative of implied volatility (IV) which indicates the change in options price for every 1% change in implied volatility. For example; Stock XYZ has implied volatility of 25%, with at-the-money call options priced at $2.5 and $2.6 (bid - ask). With a Vega of 0.2, a change in IV to 26% would give new bid-ask options prices of $2.7 and $2.8 respectively. This is why increases in volatility in underlying markets makes options prices more expensive and vice versa for low volume periods.There is no relationship between vega and option premiums but only impacts the time value built into options.
Content
OVERVIEW
Before you begin trading options, it useful to familiarise yourself with Delta, Theta, Gamma and Vega, or otherwise know as'the Greeks'. They provide a mathematical method of measuring the sensitivity of options pricing in relation to the underlying asset.
Remember:
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Vega shows investors how much option premiums will move with changes in IV
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Higher volatility results in more expensive options pricing
FINAL REMARKS
The Greeks give investors a dynamic picture of options pricing as they are constantly adapting to market conditions. Particularly useful for a means of measuring risk:reward potentials with certain strategies and grasping a full understadning of the probability of making money by using those options.