This article is part of a more broad series of research questions I address regarding Gamma Exposure. Check out this post for more.
Greeks refer to dimension of risk that an options position entails. The Greeks are used by options traders and portfolio managers to hedge different risks to their positions.
Is simple terms, the Greeks are derived based off a pricing model, like Black-Scholes, using inputs: option price, underlying stock price, days to expiration, and risk free interest rate.
The most commonly used Greeks used are Delta, Gamma, Theta, Vega.
Delta is the amount an option price is expected to move based on a $1 change in the underlying stock.
Calls always have positive delta, between 0 and 1. If the underlying stock price goes up and no other variables change, the price for the call will go up.
If a call has a delta of 0.50 and the stock goes up $1, the price of the call will go up about $.50. If the stock goes down $1, the price of the call will go down about $.50.
Puts always have a negative delta, between 0 and -1.
Gamma is the rate of change in delta for every $1 change in the stock price. If delta is the “speed” at which option prices change, you can think of gamma as the “acceleration.”
Options with the highest gamma are the most responsive to changes in the price of the underlying stock.
Gamma is highest for options with strike prices near the current underlying stock price. It is also highest for those options at the money that are closer to expiring vs. those options which are due to expire further out in the future.
Theta, aka time decay an option buyer’s biggest enemy, and option seller’s best friend. Theta is the amount the price of calls and puts will decrease theoretically for a one-day change in the time to expiration.
In the options market, the passage of time will erode an options value. Time value melts away and does so at an accelerated rate as expiration approaches.
Vega is the amount call and put prices will change, in theory, for a corresponding one-point change in implied volatility.
Vega does not have any effect on the intrinsic value of options, it only affects the “time value” of an option’s price.
Typically, as implied volatility increases, the value of options will increase. That’s because an increase in implied volatility suggests an increased range of potential movement for the stock.
If you’re trading options, you absolutely must understand those Greeks above and how they impact your trading strategies.