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Transcript
Options are complicated enough as it is.
That they contain literal Greek is, well, intimidating.
But, actually, while the Greeks do consist of unique characters, what they represent is pretty straightforward and understanding the Greeks will give you a much more clear picture of how your options price will change, its volatility, how time will affect its value, and more.
So let’s get into it.
Let’s start with Delta.
Delta is a value that is in cents and it tells you how much the price of the option will change per share with a one dollar change in the stock price.
If the Delta is 20 cents and the price of a bullish call option is one dollar, and the price.
If the stock is ten dollars, and goes to eleven dollars, the price will – in theory – become a dollar and 20 cents per share.
So, for the entire contract of 100 shares the value will have increased by twenty dollars.
That’s the math for a call option, but because put options are bearish they have negative deltas, but it works pretty similarly.
Another thing you should know about Delta: it’s viewed – as a rule of thumb – as the probability that the option will expire in the money.
So, if the Delta is 20 cents the option is seen as having a 20 chance of expiring in the money.
Ah, Theta.
Theta, just like Delta, is in cents, but it’s always negative because Theta represents how much value the option in the next 24 hours per share will lose.
A Theta of negative 10 cents means that your options price will decrease per share by 10 cents in the next 24 hours.
And because the entire contract covers 100 shares then the total loss would be ten dollars.
As an options contract gets closer to its expiration, Theta tends to increase, particularly in the final week to expiration – a sign that the options time is running out.
Onto Gamma.
Gamma is how much the Delta will change if the stock price changes by one dollar.
Here’s how that plays out:
If Gamma is five cents and Delta is 20 cents on a call option and the stock goes up one dollar, then the Delta becomes 25 cents.
So, Gamma can be used as a predictor of the stability of Delta.
To benchmark it a bit, a Gamma of 5 cents is considered pretty stable, but Gamma gets higher for options that are in the money and closer to expiring.
Why?
Because Gamma is sometimes called the Delta of Delta, and options that are close to expiring are almost out of time.
We mentioned that Theta increases as the expiration date nears, which means it’s increasingly all about that strike price getting close to being in the money, and the closer we get the higher Delta mathematically must go – in theory.
We saved the hardest one for last.
Look Vega – it’s a bit of a tough one.
Before we get to it, let’s talk about something called implied volatility or “IV” for short.
Weirdly IV has a Greek symbol – Sigma – but it isn’t considered a Greek.
That’s options for you!
Now IV is calculated using a theoretical options pricing model and what it shows is, if you look at different factors, to what degree is the market suggesting – implying – the stock price is going to move up or down.
A high implied volatility means the market thinks the price of the underlying stock is likely to make sudden swings, and a low IV means the market thinks it’s relatively stable.
IV is usually given as a percentage.
Now that you know about implied volatility, let’s get into Vega.
Vega estimates how much the premium of an options contract will change with each percentage point change of implied volatility.
Breathe in – we can do this.
Just take the change in implied volatility times Vega and you get the price change of the options premium.
For example, as earning seasons approach stock XYZ’s IV increase by two, and since the Vega is 20 cents the value of the option should theoretically increase by 40 cents.
And, that’s it: you know the basic Greeks now.
And, just a reminder, this is all theoretical.
Options are traded in an open market – there’s buyers and sellers.
But the Greeks can give you some useful benchmarks as you evaluate various trading strategies.
We hope this simple blueprint helps you on your options trading journey.
And, hey, if you still want to get more comfortable you can always use draft trading which uses real market data with all the properties of real options but without risking real cash.
Explore eToro options today.