Don't Trade Options Without Studying Greek(s)

Nov. 19, 2020 9:00 AM ET63 Comments

Summary

  • The number of individuals trading options has increased dramatically in the last two years.
  • Option strategies can provide investors with greater income or leverage. I have covered several strategies in prior articles.
  • This article covers important data points needed to successfully understand option pricing. These are known as the Greeks.
  • I will also provide examples of how they move with time and the stock’s price and changes in volatility, an important non-Greek option input.

https://www.tradingcampus.in/wp-content/uploads/2017/06/option-greeks.png

Source: photo

Introduction

The number of individuals trading options has increased dramatically in the last two years. Option buying is reported to be very popular among users of Robinhood.com. Option analysts have developed several mathematical processes to measure the movement of an option price relative to the change in both time and the underlying stock price, plus volatility. Since they all have been assigned a letter in the Greek alphabet, they are referred to as the Greeks. Understanding what they represent and how they move is critical to any option strategy being employed successfully.

I will describe each Greek, then show how they interact as the stock price and volatility change. For those new to options, read this first: Options 101

The Greeks

Option Greeks are financial measures of the sensitivity of an option's price to its underlying determining parameters, such as volatility or the price of the underlying asset. The Greeks are utilized in the analysis of an options portfolio and in sensitivity analysis of an option or portfolio of options. The measures are considered essential by many investors for making informed decisions in options trading.

Delta, Gamma, Vega, Theta, and Rho are the key option Greeks. However, there are many other option Greeks that can be derived from those mentioned above.

Source: corporatefinanceinstitute.com

This table summarizes the Greeks that will be covered.

https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/option-greeks/

Source: corporatefinanceinstitute.com

Source: corporatefinanceinstitute.com

For those who haven't opened a calculus book since college, the first derivative is a measure of the rate change of the variable at any given point. This comes into play for several of the Greeks.

For Delta, values, expressed in decimals, vary from 0 to 1 for Call options, and -1 to 0 for Puts. Delta provides the probability the option will be ITM at expiration using the current volatility. It also provides the hedging ratio an

This article was written by

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I have both a BS and MBA in Finance. I have been individual investor since the early 1980s and have a seven-figure portfolio.  I was a data analyst for a pension manager for thirty years until I retired July of 2019. My initial articles related to my experience in prepping for and being in retirement. Now I will comment on our holdings in our various accounts. Most holdings are in CEFs, ETFs, some BDCs and a few REITs. I write Put options for income generation. Contributing author for Hoya Capital Income Builder

Disclosure: I am/we are long WBA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short both the Nov 27th and Dec 11th Call options on WBA.

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