When learning Option Greeks there are four words you need to know. These words are delta, gamma, theta and vega. Option Greeks are measurements of risk that explain several variables that influence option prices.
Before we can begin understanding what Option Greeks are, we should first understand the factors which influence the change in the price of an option. Then we can better understand how this fits in with the Option Greeks.
Here are the 3 main factors that influence the change in the price of an option:
Volatility Amount
If you are long in the option, increases in volatility are normally positive for both calls and puts. However, an increase in volatility is typically negative if you are the writer of the option.
Changes in the time to expiration
If an option gets nearer to the expiration time it will become more and more negative and the profit potential will be become less and less. The nearer the option is to expiration, the faster the time value evaporates.
Another way of saying this is that the rate of loss of time value for an option with three months left to expiration is faster than that of an option with six months remaining.
Time is running out for the option to get in-the-money (when the strike price is less than the market price of the underlying security). The less time, the less value. The closer and closer options get to expiration, the less chance there is that it will happen, and there are generally fewer buyers and more sellers.
When the underlying asset changes in price
If a holder of an option has a call option, an increase in the price of the underlying asset is typically a positive situation. If you have a put option and there is a decrease in the price of the underlying instrument this is typically a positive situation.
There is another influence which is interest rates. A lot of the time these are less important. With interest rates being higher this means that the call options will be more expensive and the put options will be less expensive.
Once you understand the influences that change the price of an option you can then, advance to learning about the Option Greeks.
Delta
A option delta is the sensitivity of an option’s theoretical value to a change in the price of the underlying stock or entity.
Delta is described as the price relationship or the amount of change in price of the underlying entity to the option based on 1 point, or a dollar price move.
Delta values range from -100 to 0 for put options and from 0 to 100 for calls, or -1 to 0 and 0 to 1, if you use the more commonly used expression in decimals.
If the underlying entity moves $1 higher and the option follows penny for penny, the option has a delta of 1, which is the case for an in-the-money-option option. If the option increases in value only 50 cents for each dollar gained by the underlying entity, the delta is 50 or 50 percent.
Gamma
This is the sensitivity of an option’s delta to a change in the price of the underlying entity. In other words, gamma measures the rate of change of delta in relation to the change in the price of the underlying entity.
From this information you can make a more informed decision on predicting how much can be made or lost based on the movement of the underlying position.
Theta
This is the sensitivity of an option’s theoretical value to a change in the amount of time to expiration.
Vega
Vega refers to the sensitivity of an option’s theoretical value to a change in volatility. It measures the risk exposure to changes in implied volatility and tells traders how much an option’s price will rise or fall as the volatility of the option varies.
This is the basic information for understanding what Option Greeks are and they can help you in finding better option trading opportunities.
