Options trading is a form of speculation on the markets that involves acquiring the right to sell or buy securities such as stocks instead of the stocks themselves. It is a strategy that many favors because the upfront monetary commitment is lower, and therefore, so is the risk.
Like other forms of trading, though, it has its own unusual lingo, including the Greeks. These are Delta, Gamma, Theta, and Vega, and understanding them is essential for quintessential trading in options.
In this article, we will look at what the Greeks in options are and how they can be useful to you as a trader.
Options Contracts are used for calculating the fluctuations in the asset’s price. Call options allow you to sell an asset, and put options give you the right to sell an asset. And the price at which options are converted into a share of the underlying asset is called the strike rate. The last date of an option is known as the expiration date. All options are accomplices with a specific value or price that is known as premium.
Volatility can be defined as changes in the option’s premium, or market value, which in turn determines its expiration date. These changes can occur due to a variety of reasons, such as overall market changes, economic alterations in the company, geopolitical risks, etc.
Another factor crucial for investors is implied volatility. Implied volatility represents the likely rise in the price of an asset. Also known as implied vol, this feature plays a huge role in notifying the investors beforehand about the fluctuations in the costs of security or stock and option. Together, the volatility and implied volatility help determine any changes in the option’s premium.
Intrinsic value is the value of an asset’s market worth. This underlying value of the asset is completely independent of the asset’s market price. When the difference between the strike price and the underlying value of any asset turns out to be a profit, this is called the intrinsic value.
Therefore, move towards the concept of Greeks and how it impacts the options.
What are the Greeks?
The Greeks – so named because they employ letters taken from the Greek alphabet – are different ways of calculating the risk level of a particular trade. Having a grasp of how each works is very important in options trading.
Delta is probably the most frequently used Greek and is often referred to as ‘the leader’. It gives you an indication of how much the price of your option contract on security will alter based on changes in the price of the security itself.
Usually, these forecasts are made based on a £1 change in the price of the security. When trading options on security like stocks, you can either buy a call option or a put option.
A call option means acquiring the right to purchase the securities in question on a set date, while a put option buys you a contract to sell them at the agreed date. A typical example of how Delta works as a metric for calculating prices is as follows:
You buy a call option for £5 on stock worth £250, with a Delta of 0.20. The stock then rises in value by £1 to £251, which will mean that the new price of your option is £5.20.
This is the second Greek, sometimes called ‘the sidekick’ by options traders. It measures changes in the rate of the Delta metric over periods of time.
Because Delta will change as the price of the actual securities does, traders need a way to work out whether their trading option is liable to make the strike price before the due date, and that is what Gamma provides.
To offer an example of how it is calculated: you buy an option on stock worth £250 for £5. The Delta is 0.20 and the Gamma is 0.05.
The price of the stock then rises by £1 to £251, taking the price of the option on it to £5.20. The Delta is now 0.25 while the Gamma is 0.07.
Gamma lets you know whether the price of the option is stable or volatile when there are changes in the price of the stock. That helps you measure how risky buying options on particular securities is.
Theta measures the drop in the value of an option over a period of time. It is a negative metric often described as being ‘the naysayer’ but it is very important.
That is because options often do decline in value the closer they get to their due date because there is less time for investors to take them up and make money on them. Theta is used to determine the optimum time to pick up your option, as well as whether it is worth picking up.
This particular number is usually a minus, and if your option has a -0.05 Theta, its value of it will go down by 5p per day.
Sometimes called ‘the wildcard’, Vega is a metric for determining how much the price of your option will be affected by the implied volatility (Sigma). This implied volatility number shows you how likely stocks are to undergo sharp rises or drops in value, with a high one meaning they will and a low one meaning they will not.
Vega measures changes in the cost of the option based on this implied volatility number.
There are other Greeks, known as the minor ones, but these four are the most frequently deployed.
There is no question that acting based on the four Greeks is a good thing for options traders. Each of them provides a different metric for measuring the risk level, and balancing risk against reward is the key to success with any trading strategy.
Rho is the unit of measurement of any derivatives price change with respect to risk-free interest rate changes. Greek alphabets have a list of letters, where Rho comes on the 17th number, and it obtains from the Phoenician letter res . Rho is categorized as a liquid consonant, that has a critical impact on morphology, it is joint with Lambda, the 11th letter of the Greek alphabet, Mu, the 12th letter of the Greek Alphabet, and last Nu, the 13th letter of the Greek alphabet. If you are thinking to trade with Rho, remember these points:
- Interest rate and call option premium are directly proportional to each other, when one increases the other rise as well.
- Interest rate and put option premium are inversely proportional to each other. When the interest rate increase, the value of the put options decrease.
- When the interest rate rises, the difference between the put option and the call option also gets wider.
Hopefully, you now have an idea of what Greeks are and how to deploy them when trading in options.
Which Greek is Profitable for Option?
Before trading, it is important to understand the concept of Greek. Delta and theta have a great impact on your profit and loss, so understanding them is essential. Delta helps to know whether your investment will make a profit or not in the initial phase. On the other side, Theta helps to know the value an option will lose day by day.
To increase the profitability of your trade, it’s crucial to understand the above-discussed five prominent Greeks. Vomma, Zomma, Lambda, and some others are the minor Greeks that slightly impact your options. A good understanding of these can benefit your current option price and help you to create a strategy.
We hope this blog will help you to understand the concept discussed above and the things you should consider while trading in options.