Lesson 9: What are the Greeks?

"Greeks" is a term used in the options market to describe the different dimensions of risk involved in taking an options position. These variables are called Greeks because they are typically associated with Greek symbols. Each risk variable is a result of an imperfect assumption or relationship of the option with another underlying variable. Traders use different Greek values, such as delta, theta, and others, to assess options risk and manage option portfolios. Watch this next video by Tasty Trade as they use other examples to explain what Greeks are used for.

The Greeks

The Greeks are a number of key factors that influence the price of options contracts and are called such because of their names, which are all derived from Greek letters of the alphabet. The Greeks are all intimately related, but in the interest of simplicity, we describe them below based on what would be true for one Greek, holding all else constant.

 

Delta: The amount an option price is expected to change based on a $1 change in the underlying stock. For call options, this is a positive number between 0 and 1. For put options, this is a negative number between 0 and -1. This number is not static, and changes as an options contract near expiration and if it becomes in-the-money. Delta will approach 1, or -1, for a call or put option, respectively, if it is near expiration and in-the-money, while it will approach 0 for contracts that are out-of-the-money as expiration nears. Technically, the delta is an instantaneous measure of the option's price change, so that the delta will be altered for even fractional changes in the underlying instrument.

 

Gamma: The rate of change in an option’s delta based on a $1 change in the price of the underlying security. The price of a contract with high gamma, a reading near 1, will be very responsive to changes in the price of the underlying security. A contract with low gamma, a reading near 0, won’t be very responsive to price changes. Gamma is typically highest for at-the-money stocks near expiration.

Theta: The rate of change in an option’s theoretical value for every one-day change in the time remaining until expiration, holding all else constant. Theta becomes larger as an option nears expiration. Theta is also known as a contract’s time value. Time has value, because with more time until expiration, there is a greater probability of the underlying security’s price moving enough for the contract to pay off. See also Time Decay.

 

Vega: The rate of change in an option’s theoretical value in response to a one-point change in implied

volatility. Vega typically increases as implied volatility increases, because a more volatile stock has a greater chance of moving enough to end up in-the-money- before expiration.

 

Rho: The amount the theoretical price of an options contract is expected to change based on a one-percentage-point change in interest rates, holding all else constant. Rho typically matters most for longer-term options, where a change in interest rates can lead to a greater “cost of carrying,” or a greater opportunity cost associated with making the trade versus pursuing another investment. Gamma!

Videos to help you understand

If I had to explain theta to someone who was a complete beginner. This is the best video I know of that explains it in simple terms. For those new, it’s important to grasp the effects of the Greeks. Theta pertains. To time decay of a specific contract. It is the reason why we preach buying a longer expiration if you plan on swinging:

 

https://youtu.be/4X3HBFntkds

https://youtu.be/t2ty3MuQ68Q

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