Learn to Trade Option Greeks
It's easy to get frustrated by the option Greeks, but if one can strip out the puzzling buzzwords then the fundamental ideas behind them are not at all hard.
There are lots of things that you get to make a choice concerning an option you intend to buy or sell.
There can be a number of elements that have an impact on option prices, but listed below are just 4 significant ones that we'll examine now.
1.
The price of the underlying stock - DELTA It is quite intuitive that the price of the underlying stock impacts the price of the option.
Options that are in-the-money cost more compared to options that are out-of-the-money.
If we buy a call option and the stock soars, then our option increases in value.
If we buy a call option and the stock falls, then the value of our option decreases.
We need to have some kind of measurement that informs us how the value of our option varies if the underlying stock moves.
This measurement is DELTA.
The technical description of delta is how much the price of an option changes for every $1 increase in the underlying stock.
EXAMPLE: If the underlying stock increases by $1 and the option price goes up by $0.
7, then the option delta is 0.
7.
Call options normally have positive deltas, because they generally rise in value when the stock goes up.
If the stock increases by $1 and the option price goes down by $0.
3, then we say that the option delta is -0.
3.
Put options normally have negative deltas, because they generally become worth less if the underlying stock goes up.
A good way of thinking of option delta is to understand that if you simply buy a stock, the delta is exactly 1, and when you short the stock, your delta is exactly -1.
2.
How quickly the price of the underlying stock can change - VEGA When the volatility of a stock goes up, the options on that stock tend to become more expensive.
This makes sense, because when there are larger swings in the stock price, there is more possibility of the option making money before it expires.
The technical explanation of vega is exactly how much the price of an option moves for every 1% increase in the volatility of the underlying stock.
It's simple to remember that vega relates to volatility because they both begin with V.
3.
How long we have left before the option expires - THETA All options have an expiration date at a point in the future.
In general, the longer time there is left before the option expires, the more that option is worth.
This makes sense because there is considerable time for the underlying stock to move in our direction.
If our option is out-of-the-money with only a couple of days left, it probably won't be worth very much.
The technical description of theta is how much the price of an option changes as each day passes toward expiration.
If we buy an option, we have negative theta.
Generally, the option will decline in worth for each day that passes.
This is why many people like to sell options - for every day that the underlying stock doesn't move much, the value of the option drops.
It's useful to remember that theta relates to the effect of time on an option because they both begin with T.
4.
How quickly delta can change for our option - GAMMA Gamma is a lot more complicated that the three option Greeks we have discussed so far, and you must have a firm grasp of delta to understand it.
We already know what delta is, and that the delta of an option is not constant.
Remember that delta measures how much the price of an option changes for every $1 increase in the underlying stock.
It gets complex because once the underlying stock has increased by $1, the delta then changes very slightly.
If the stock rises by another $1, then the delta changes again.
Delta is not constant for an option.
The technical explanation of gamma is how much the delta changes when the underlying stock rises by $1.
Gamma is probably the least well understood of the four basic option Greeks by options traders.
Conclusion You now know the 4 basic option Greeks - delta, vega, theta, and gamma.
It's not necessary to know everything regarding these measurements, but you should be aware of the basics of how each of these risk measures can easily have an effect on the strategy you decide to use when you trade options.
There are lots of things that you get to make a choice concerning an option you intend to buy or sell.
There can be a number of elements that have an impact on option prices, but listed below are just 4 significant ones that we'll examine now.
1.
The price of the underlying stock - DELTA It is quite intuitive that the price of the underlying stock impacts the price of the option.
Options that are in-the-money cost more compared to options that are out-of-the-money.
If we buy a call option and the stock soars, then our option increases in value.
If we buy a call option and the stock falls, then the value of our option decreases.
We need to have some kind of measurement that informs us how the value of our option varies if the underlying stock moves.
This measurement is DELTA.
The technical description of delta is how much the price of an option changes for every $1 increase in the underlying stock.
EXAMPLE: If the underlying stock increases by $1 and the option price goes up by $0.
7, then the option delta is 0.
7.
Call options normally have positive deltas, because they generally rise in value when the stock goes up.
If the stock increases by $1 and the option price goes down by $0.
3, then we say that the option delta is -0.
3.
Put options normally have negative deltas, because they generally become worth less if the underlying stock goes up.
A good way of thinking of option delta is to understand that if you simply buy a stock, the delta is exactly 1, and when you short the stock, your delta is exactly -1.
2.
How quickly the price of the underlying stock can change - VEGA When the volatility of a stock goes up, the options on that stock tend to become more expensive.
This makes sense, because when there are larger swings in the stock price, there is more possibility of the option making money before it expires.
The technical explanation of vega is exactly how much the price of an option moves for every 1% increase in the volatility of the underlying stock.
It's simple to remember that vega relates to volatility because they both begin with V.
3.
How long we have left before the option expires - THETA All options have an expiration date at a point in the future.
In general, the longer time there is left before the option expires, the more that option is worth.
This makes sense because there is considerable time for the underlying stock to move in our direction.
If our option is out-of-the-money with only a couple of days left, it probably won't be worth very much.
The technical description of theta is how much the price of an option changes as each day passes toward expiration.
If we buy an option, we have negative theta.
Generally, the option will decline in worth for each day that passes.
This is why many people like to sell options - for every day that the underlying stock doesn't move much, the value of the option drops.
It's useful to remember that theta relates to the effect of time on an option because they both begin with T.
4.
How quickly delta can change for our option - GAMMA Gamma is a lot more complicated that the three option Greeks we have discussed so far, and you must have a firm grasp of delta to understand it.
We already know what delta is, and that the delta of an option is not constant.
Remember that delta measures how much the price of an option changes for every $1 increase in the underlying stock.
It gets complex because once the underlying stock has increased by $1, the delta then changes very slightly.
If the stock rises by another $1, then the delta changes again.
Delta is not constant for an option.
The technical explanation of gamma is how much the delta changes when the underlying stock rises by $1.
Gamma is probably the least well understood of the four basic option Greeks by options traders.
Conclusion You now know the 4 basic option Greeks - delta, vega, theta, and gamma.
It's not necessary to know everything regarding these measurements, but you should be aware of the basics of how each of these risk measures can easily have an effect on the strategy you decide to use when you trade options.
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