Options Terminology – 2
Options Greeks
Option traders are often refer to the delta, gamma, vega and theta of their open option positions. Collectively, these terms are known as the “Greeks“. These greeks can not be simply looked at the daily option tables. They need to be calculated. The greeks represent the price sensitivity of any option with respect to the underlying parameters such as price of underlying, time to expiry and implied volatility.
Let’s now discuss the first greek.
1. Delta The Delta of an option is measure of the sensitivity of the option’s price to changes in the price of the underlying asset. That means it can be calculated by measuring the change in an option premium brought about by a small change in the price of the underlying. This would be calculated using option pricing models such as Black-Scholes.
The delta value will be between 0 and 1. For example if the change in the underlying price was 10, and perhaps the option increased by 6, this would give a delta 6/10 = 0.6.
- A delta 0 means the premium is totally insensitive to small change in the price of the underlying. This will be the case of far Out-Of-the Money options
- a delta 1 means the premium is fully sensitive to small change in the price of the underlying, that means the premium will change by exactly the same amount as the underlying. This will be the case for deep In-The-Money options
To know about out-of-the money and in-the-money options read my other post “Options Terminology“.
Call option deltas are positive because the premium will rise when the price of the underlying rises.
Put option deltas are negative because the premium will fall when the price of the underlying rises.
Lets have a look at the summary of deltas.
| Instrument | Delta |
| Physical asset or future or deep ITM call | +1 |
| ATM call | +0.5 |
| Far OTM call or Far OTM put | 0 |
| ATM put | -0.5 |
| Deep ITM put | -1 |
Delta value can also be calculated for portfolios (containing futures, and options) to measure the sensitivity of portfolio to the underlying price movements, and the calculated delta is known as “cumulative delta”.
Cumulative deltas help to gauge what is required to hedge a portfolio. A portfolio with cumulative delta or 0 is insensitive to price movements of the underlying and the portfolio is often referred as ‘delta neutral’ or ‘delta hedged’.
Lets now discuss the second greek.
2. Gamma It is the measure of how delta changes with respect to the change in the underlying price. It is small when the option is deep-in-the money or far-out-of-the money. It is at its greatest when the option is at-the-money, especially when the option is close to expiry.
Short-dated ATM options are more volatile than longer-dated ones, and these differences may represent an opportunity for trading profits.
3. Vega It is a measure of how a 1% change in the implied volatility affects an option’s price. It is always positive for long option positions – both calls and puts. It is greatest for at-the-money. The further option goes in- or out-of-the money, the vega will get smaller.
4. Theta It is the measure of the rate of decline of an option’s value due to the passage of time. That means theta represents ‘time decay‘ on the value of an option. If all other factors are held constant then the option will lose its value as time moves closer to its expiry. Theta represents the fair value of an option per day.
All these greeks are used in combination to derive various trading strategies.
Folks, thats all about Greeks!!!
