Options Greeks are a set of calculations used to measure the various factors that may affect the price of an options contract. They help traders make more informed decisions with respect to what and when to trade.
DELTA
- The Delta of an options contract measures the change in an option contract’s price as a result of a change in the underlying’s price.
- It helps determine the likelihood that an option will expire in the money (strike price below the underlying’s market price for call options or strike price above the underlying’s market price for put options). For example, if a call option has a delta of 0.30, there is a 30% chance that the option will expire in the money.
- The higher the delta, the bigger the price change.
- The delta of an option is variable and changes with respect to changes in the price of the underlying and over time. Read more.
GAMMA
- The Gamma of an options contract measures the rate of change/responsiveness of its delta with respect to a change in the price of the underlying.
- It is the first derivative of the delta and is used to determine price movement relative to the amount the contract is in/out of the money. For example, a call option has a delta of 0.30. If its underlying increases by Re.1, its delta will change. Assuming delta to now be 0.50, its gamma is 0.20 (the change in delta)
- It is the second derivative of an option contract’s price (premium) in relation to the price of the underlying.
- It is at its largest value when the option is near/at the money and is small when the option is deep/out of the money.
- Short positions have a negative gamma and long positions have a positive gamma value.
- The price of near at the money options is more responsive to price changes in the underlying. Read more.
THETA
- The Theta of an options contract measures the amount the price of an option decreases each day as the option nears its expiry (if all factors remain constant). It represents price erosion over time, also known as time decay.
- It is the time component of an options contract and indicates the amount of money a contract is going to lose on a per-day basis, until expiry.
- It is a negative value and gradually increases every day. This is because time decay tends to accelerate as an option approaches expiry since there is less time left to earn profit from the trade.
- Hence, it is said to be the enemy of option buyers and the best friend of option sellers. Read more.
VEGA
- The Vega of an options contract measures the amount of change in the contract’s premium as a result of a 1% change in its Implied Volatility (IV). IV represent the likelihood of a change in the underlying’s price.
- Vega indicates changes in expectations for future volatility and is positive.
- Higher volatility makes options more expensive since it is more likely to reach its strike price.
- The longer an options contract has until expiry, the more volatility will affect its price. Hence, Vega falls as a contract approaches expiry and increases as the underlying moves closer to the strike price. Read more.