THE OPTIONS GREEKS
Greeks… Strange name, isn’t it? Technically, Greeks are outputs derived from theoretical options pricing models (e.g. Black & Scholes or its newer variants) that attempt to estimate how the option premium may change according to change in the behaviour of the underlying or the passing of time. In other words, the pricing model provides a price for an option and the Greeks are individual sensitivity parameters or drivers to that price in terms of : price change in the underlying (Delta), volatility change (Vega), and the passage of time (Theta).
Thus equipped with the right tools to manage and understand the risk associated with trades, the options trader can pick and choose certain strategies according to the environment or forecast for the underlying. Greeks are applicable to individual options as well as for any combination of them e.g. the overall Delta is the sum of all options Deltas composing it.
Sounds simple enough right ? Well, looks can be deceiving… The Options Greeks course covers the subtleties like the volatility skew and the interdependence of those parameters i.e. they influence each other and many strategies require keeping a certain ratio like Vega/Theta for instance. What is important to understand at this point is that each strategy, each adjustment can be viewed in terms of a “Greek signature” or profile, knowing that risk and reward can be a complex equation one tries to keep as simple as possible. Each time one adjusts a position: what is the cost for the risk one seeks to hedge ? Is there an additional risk somewhere else?
In any case, regardless whether you learn the Greeks yourself with the help of numerous resources on the Internet or not, they form the essential checklist, a non-negotiable prerequisite to learn simple or complex strategies. Trading options without a sound knowledge of the Greeks is merely suicidal.
The 5 Greeks are detailed below in individual pages:
- DELTA i.e. sensitivity to price change
- GAMMA i.e. sensitivity to Delta change
- THETA i.e. sensitivity to Time
- VEGA i.e. sensitivity to Implied Volatility
- RHO i.e. sensitivity to change in risk-free interest rates
Individual options have different responses to “Greeks” that can be briefly summarised in the table below:
If you do not feel at ease with the Greeks yet, please go back to the Basics and/or the Recommended Reading pages. OM is here to help, so please also check the mentoring classes available on Options Basics. Contact us at any time for detail.
The Tasty Trade TV network is also very interesting for beginners to intermediate traders, also linked to Dough. Tom Sosnoff is the founder of TOS, one of the best options brokers unfortunately not available to European customers.