Do you know these four Greek letters which are used in options strategy?

Shubham Agarwal

It is always profitable to go back to the books every once in a while, to make sure that the process of trading this complex instrument of ‘options’ remains simple and error free.

In an attempt to do so let us try and revisit four such Greek letters which are often used while describing the option positions.

We will try and define each of them at first and then follow the definition with a simple one sentence implication of the same on our profitability.

Shubham Agarwal

CEO and Head of Research|Quantsapp Private Limited

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In my experience, these four Greek letters are super powerful in summarizing our position across price, time and volatility dimensions no matter how large the position is. Hence, I believe they are the 'must-know' definitions for every trader.

Most option calculators and option portfolio showcasing tools come equipped with the Greeks; hence, they are easily available across the internet.

Also, all these Greeks change with a change in price and time, but would at least help us understand where we stand right now.

Let us go in further detail:

#1 Delta:

Delta is the rate of change of the option price with respect to the price of the underlying. Deltas can be positive or negative.

Deltas can also be thought of as the probability that the option will expire ITM or in-the-money. Having a delta neutral portfolio can be a great way to mitigate directional risk from any adverse market moves.

Utility: Look at this number as a representation of our position in the underlying. Positive 0.50 delta means the option position represents long 50 percent of exposure in the underlying and vice-versa.

#2 Gamma:

Gamma is the rate of change in the delta of an option. Gamma values are largest in ATM or at-the-money options and smallest in ITM and OTM or out-of-money options.

Gamma sensitivity exponentially increases as expiration nears. Gamma is important to keep in mind when hedging deltas because low gamma positions require less maintenance than high gamma positions.

Utility: As we all know options rise exponentially with price and the factor that adds this compounding element to option premium is Gamma. For us, the takeaway is Positive Gamma is Pro-Direction, while Negative Gamma is Pro-Consolidation.

#3 Theta:

Theta measures the rate of change in an options price relative to time. This is also referred to as time decay. Theta values are negative in long option positions and positive in short option positions.

Initially, out-of-the-money options have a faster rate of theta decay than at-the-money options. However, as expiration nears, the rate of theta decay for OTM options slows while the ATM options begin to experience theta decay at a faster rate. This is a function of Theta being a much smaller component of an OTM option's price, the closer the option is to expire.

Utility: Theta number has to be looked at if we are going to hold an option for one more day. For long option, the negative Theta number is the amount of money that would be lost with the passage of one more day.

#4 Vega:

Vega is the Greek metric that allows us to see our exposure to changes in implied volatility. Vega values represent the change in an option’s price given a 1 percent move in implied volatility, all else equal.

Utility: Time and again when we have talked about event trading and how the concept of implied volatility first raises premiums ahead of the event on the expectation of volatility and drops the premiums as the unknown is over.

Vega lets us know for the position held what is the money that can be lost if the implied volatility were to drop by 1 percent. It is very useful to track this, especially with the mega event of the Lok Sabha polls around the corner.

This brief is an introduction to the utility of these 4 Greek letters. Each of them is a  subject in itself, and a lot has been written on them.

I would urge to raise familiarity on these Greeks as much as possible because Greeks are like X-Ray reports of the option portfolio – knowing them helps instantly figure out the health , and more importantly devise a possible remedy.

(The author is CEO & Head of Research at Quantsapp Private Limited.)