How to Apply Option Greeks in Trading Effectively?

Option Greeks are sensitive to a specific market variable, so they are even called ‘option sensitivities’. Sensitivity signifies some form of risk. The intensity of sensitiveness for open option position is magnifying because they apply their leverage on option position at the same time.

  • Time cannot be stopped, hence Theta has incessant effect
  • Markets movements cannot be stopped, hence Delta moves consistently
  • Traders are always motivated by sentiments, which interprets the market volatility, hence Vega revolves constantly

Understanding and calculating options sensitivity with respect to price shifts, IV changes, time decay and interest rates is very helpful. It can make a vast difference between bust and boom.

Delta

  • Delta measures anticipated price change of specific option at $1 change
  • Calls have positive, while puts have negative deltas
  • Delta even provide probability measure, when option money will expire
  • Delta is used to evaluate options alternatives like at-the-money, in-the-money, and out-of-the-money, while buying
  • Covered call writers use delta to compare probability with potential return from the selling of call

Gamma

  • Gamma reflects change in delta with respect to $1 movement of underlying stock price
  • Gamma is expressed as percentage
  • Gamma fluctuates constantly
  • Gamma increases, when stock price is close to options strike price, when expiration comes near
  • Gamma percentage decreases (close to 0), when option goes deep or out-of-money, as expiration draws near
  • In low volatility, time value also drops but goes up dramatically, when underlying stock price advances towards strike price, so Gamma percentage is high
  • In high volatility condition Gamma is apt to be steady across all the strike prices because of increase in time value as they near expiration time the price displays low and steady Gamma percentage

Theta

  • Theta directly measures time decay per day
  • As the option nears expiration period this amount escalates rapidly
  • More Theta means more risk, if the underlying price moves in opposite direction than expected
  • Theta for long term options is almost 0 and for short term option is higher, especially for at-the-money alternative
  • High volatility stocks have high Theta in comparison because time value is high on these options and they erode more daily

Vega

  • Vega is a measure of impacts of changes in volatility of underlying option price for every 1% changes
  • Vega is added, when volatility rises and subtracted when volatility drops, while calculating new option price
  • When volatility is high options are expensive and when volatility plummets option price falls
  • Vega is high, when the time to option expiration is more.
  • Time value is sensitive to volatility changes.

Rho

  • Rho measures option price with respect to changes in the interest rates.
  • Rho is useful for traders to evaluate long term strategies.
  • When the underlying stock gets more expensive Rho also has a propensity to get large.

For new traders application of options Greeks can be fairly complicated. If you are serious about investing in options then it is wise to learn the application of option Greeks in detail.

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