Know Your Option “Greeks”
07/21/2011 3:30 pm EST
Option "Greeks" like Delta, Theta, Gamma, and others are important measures of option pricing, and Dan Passarelli, author of Trading Option Greeks, decodes them.
I’m here with Dan Passarelli to talk about option “Greeks.” We’ve heard about the Delta, the Theta, the Gamma, but what do they mean and what’s the most important one for us to watch?
So Dan, Delta is the one that’s most common. Can you talk about how that impacts the price of options?
Delta is surely the most important of the Greeks for most option traders. What it measures is the option’s directional sensitivity to changes in the underlying.
For example, if you’ve ever bought a call and you’ve seen the stock go higher—maybe the stock goes a dollar higher—you notice your call probably doesn’t rise by a dollar. It rises by something less.
That’s exactly what Delta measures. It’s stated in percentages, so if there’s a call that has a 60 Delta, if the stock rises by $1, the call should rise by 60% of a dollar, so 60 cents.
Now are those theoretical numbers or are they pretty solid? If I buy it that day and it moves that day, can I expect it to get pretty close to that 60 cents?
Yes, they are solid numbers, but Delta is not the only factor that affects the value of that option.
It’s also Theta, which measures time decay; and Vega, which measures changes in implied volatility.
So, you might have a 60-Delta call, watch the stock rise by $1, and say, “Wait a minute, why did my call only rise by 35 cents? Delta says that it’s supposed to have risen by 60 cents.”
That’s because Theta also affected the value, and perhaps Vega affected the value as well.
So, really, you can’t really look at any one of the Greeks individually. They all work in harmony.
So, the closer I am to expiration, I would imagine, the more power Theta has over Delta, and I might want to pay more attention to Theta?
Yeah, exactly. You always have to look at Delta, and you always have to look at Theta too, especially during expiration week when there’s only a few days left and time decay is its most prominent.
See video: Trade Expiration Week Like a Pro
Alright, now, where do I find the information on these Greeks, is it in the option chain on most people’s trading platforms?
Right. Really, any options-friendly broker will have the Greeks listed in their options chain. You just simply go across the column, and you might have to go into Settings and set it up for yourself, but you’ll be glad you did because you get so much information by using the Greeks.