2 Most Important Option Greeks
10/01/2012 3:57 pm EST
Option trading expert Dan Passarelli explains the two most important option greeks traders should understand.
My guest today is Dan Passarelli, and we’re talking about option greeks. He is an expert at this. He has written a book about it. So Dan; I know Greece can get really kind of complicated for option traders, but are there a couple of maybe the top two, if you will, that people should know about and really understand?
Sure. The absolute most important top two greeks that every trader needs to understand – if you’re trading options – are delta and theta. They are not very intimidating once you understand what they are. Delta simply measures an option position’s sensitivity to changes in the underlying asset; so if the stock goes up by a dollar, the option position profits or it loses by the amount of its delta. It is kind of like a percentage. If the delta is 35, the option position makes or loses 35% as much as the underlying stock.
Does it change in real time just like the price of an option changes?
Yeah, it sure does. Then the other greek is theta, and that is really important as well. Whenever you buy or sell an option, you either make or lose money as time passes, and that is independent of direction; so you need to look at that as well, so theta measures the rate of change of an option’s value as time passes. If a theta is .02 on your option chain, it means it loses two cents a day, all else held constant. As time passes, that can really add up and make a big difference.
So when I am choosing an option out of a chain to either buy or sell or set up some sort of spread, do I need to look at all of those option greeks and then make a strategy based around what those numbers are and whether or not I will buy and sell them? I mean how do I incorporate those?
Think of them as sort of the dashboard of your car. They tell you all the information that you need to know—in the case of trading—to manage your risk. You are looking at your car; you look at your speedometer. You look at your fuel gauge. You need to know these things to understand what you need to do. Same thing with the greeks; hey, my delta is this; okay, so I have this risk. I need to do this if this happens. Same thing with theta and vega and gamma as well if you incorporate those.
All right; so your book is probably a great start to learn about these things. Is it just practice in incorporating these as well?Yeah, I mean step one is learn—get a book on it, take a class on it—get that information; and then, of course, step two is practice. The more you familiarize yourself with these sorts of things, the better you are going to be with them.