Option Greeks Explained

Do you know what Option Greeks are?

Do not worry of you don’t most people either do not know what they are or think they are too difficult to understand to even try.

Good news, they are not difficult at all. Further good news, the main one we use is Delta so you do not have to be an expert in all of them. We also use Theta but it is not as critical to our trade as far as it’s value when we trade, although it is VERY critical to us making money through time decay.

The others we sometimes look at are Vega and Gamma but in we really do not focus on them much.

Image result for option greeks

Delta  – This is the most important of the option greeks we look at. In simple terms it represents the amount an options moves per $1.00 move in the underlying security. So if an option as a delta of .20 (20) then every time the underlying security moves $1.00 then the option moves $.20.

If XYZ security moves from $27.00 to $28.00 and you hold a long call with a Delta of .20 priced at $1.50 then it would now be worth $1.70. Keep in mind that Delta’s are not static, they change as the security price changes. The more in the money an option is the higher its Delta will become until it approaches 1 which means the option price would change exactly as the underlying security price changed.

Theta – Theta is a measurement of how much an option price changes per day assuming the underlying security price stays the same. So a Theta of .70 would mean the option price is decaying at $0.70 per day. This number can change depending on the underlying security price action.

Gamma – Gamma is an estimate of how much Delta changes if a stock moves $1.00.

Vega – Vega measures how much an option price will change per 1% change in volatility. This can be an important number if you are trading based on expected moves in volatility. While we do trade expecting volatility to move in a certain direction we still do not really look at Vega that much.

No, we did not forget about Rho, we just do not use it.

Some traders use Delta, Theta, Gamma and Vega when trading option positions. We have found that Delta and Theta are the most important to our trading style.

The best way to learn how the option Greeks change as the underlying price changes on a security is to paper trade Image result for paper tradingsome positions and keep a spreadsheet on options changes.

Many of our trades are based on Delta values and use it in some strategies to determine enter and adjustment prices. We tend to watch Theta to see if the position is moving toward profitability for us.

Originally Published on Trade4Profits.com by Jim Dawson

If you want to learn more about how we trade, check out our books.

 

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