Understanding Greek Options

Understanding Greek Options

Submitted by adil on Thu, 10/09/2014 - 07:38

Understanding Greek Options is Very Important

A better and advanced knowledge of Greeks can save you from big loss when you trade. Therefore acquiring information and understating about Greeks is highly recommended for traders.

In purchasing a call, underlying price can move against you ultimately dropping implied volatility as well as time decay. While in case one sells a call, one runs risks of driving the prices against one’s self; facing a rise in implied volatility as its result. But here time decay moves in one’s favor. Dealing in these risky positions, you need to know about Greeks in order to save yourself from loss. Three basic Greeks Delta, Vega and Theta are explained below with examples. These can help traders to secure their money and discard the risk.

Delta: It measures sensitivity of options when underlying asset’s price changes. For example we may use IBM ($110.09) January call strikes. Let’s see the figures. 90.2 Delta is in January 100 call, 110 call carries 52.9 Delta, 125 call holds 2.27 Delta. 100 Strike retains the highest Delta while 125 Strike holds the lowest.

Traders use these figures as a probable change. From their eye we can say that 100 Strike contains 90.2 % chance that it will expire in money. Chance is of  52.9 % on 110 Call. 125 Strike has 2.27% chance. We assume it if not a major trend is seen in the underlying security.

Vega: When volatility changes, it runs risks of loss and profits. This Greek measures these sorts of risks. We shall continue with the same IBM example. January 110 Call contains 3.01 Vega, 105 has 1.27 and 100 has 0.49. With the Strike running out of money, Vega rises higher. This shows that farther Strikes that are out of money reaches at high risk if volatility falls.

It also applies to farther out months. As the time gets out a bit farther, 110 Strike call has high Vega premiums. Perhaps that’s the reason LEAP options are highly risky when it comes to changes in volatility. But that doesn’t mean these are not profitable. The point is that Vega is used in order to determine your risk when volatility changes.

Theta: Time decay is measured by this Greek. As time always decays till the moment of expiration of the option, Theta always comes in negative. It is better to know your Theta before entering into a trade. If Theta of January 110 Strike is -7.58 then it loses $7.58 time value everyday. Decay increases when expiration gets close. That’s the reason farther out months face considerably slow rate of decay but higher risks from the other two options Delta and Vega. The decision to choose between fast decay and volatility risks is up to you.

The main point is that you should have knowledge about necessary Greeks. Profit and loss depend upon how you choose and deal with these options. Once a trade has got a good knowledge of these options, he will take advantage of low risk scenarios.