Option Greeks Basics: The Gods In Option Trading |

By Trader Pit

July 7, 2021


Option Greeks are used in trading option contracts to estimate what the price of an option contract will be at a future date. The Greeks include the delta, the vega, and theta. They are also used in the calculation of the dollar cost of the option. The Greeks are helpful because they can make us more aware of which options we should be buying, and which options we should be selling.

Option trading is a way to make money in the market, by trading the time value of an option, and the price fluctuation of options. Understanding the Greeks is the base of every successful option trader.

*Options Trades Explained: The gods of options trading | by Mark Duggan, Macrostrategy, 7 April 2018* Mark Duggan’s introduction to the Greeks, Part 1 of 2. *Hey Trader, What’s An Option?* Option traders typically trade options to achieve a specific objective. For example, to generate income or to speculate. An option may be used to generate a set amount of cash, or to turn a gamble into a small profit. In either case, to use an option to its full potential, traders must understand how options work.

An introduction to the basics of Greek options: What is a great cricket match? It is simply a brilliant performance by the batsman, a bowler winning five, or a brilliant catch or strike of the ball by a fielder. Or it’s a combination of all of the above, plus some critical points in the game.

Take the example of the first World T20 final in 2007. The most important match of the tournament. India and Pakistan, sworn enemies. There is no greater facility in the world of cricket. But what made this match memorable was the quality of cricket played. As a result, India won the World Cup final by a margin of 5 points.

But what made this match memorable? It was thanks to Gautam Gambhir (75 off 54 balls), Rohit Sharma (30 off 16 balls) that India were able to score competitively, Robin Uthappa brilliantly removing Imran Nazir, Misbah-ul-Haq or M. S. Dhoni giving Joginder Sharma the last word to end the match. I think it was a combination of everything that made it a memorable event.

What are the Greek options?

Likewise, option greeks are the ingredients of a recipe that ultimately helps price options. Options Greeks are several factors that help the options trader when trading options. You can use these Greeks to determine the premium price of options, understand volatility, manage risk, etc. These Greeks also have a great influence on others.

There are four types of Greek options: Delta, Gamma, Theta, Vega and Rho. In this article we will discuss them.

Quick tip: If you are new to options trading, you can read our series of articles on options here.

Delta option

Simply put, delta measures the change in the value of a premium relative to the change in the value of the underlying asset. For a call option, the delta varies between 0 and 1 and for a put option between -1 and 0.

The above option string for Nifty at 09:57. The Nifty Spot is trading at 9320.

The above option string for Nifty, Stand: 10:07 AM. The Nifty Spot is trading at 9316.

From the two tables above, it is clear that if the value of the Nifty changes slightly, the premium per option will change. The premium per 9100 EC is 291.65 in the first option chain and 289.40 in the second option chain.

Now suppose I am bullish on the market, how can I find a premium for all strike prices if I expect the spot Nifty to trade at 9400 by the end of the day. That’s where Delta comes in.

For a call option, assume that the delta of the strike price is 0.40. The value of the premium therefore changes by 0.40 points for every 1 point change in the value of the Underlying. Let’s say I buy 9350 CE at a premium of 142.70. The spot price of Nifty is 9316 and the delta of this option is .40. And as the spot price of Nifty climbs to 9350 by the end of the day.

The change in premium is therefore = (9350-9316)*0.40 = 14.4 points. The new premium would therefore be = 157,1. If the spot rate falls to 9250, the change in premium = (9250-9316)*0.40 = 26.4 points. The new premium in this case would therefore be = 142,7-26,4 = 116,3.

Dependence of the delta value on the monetary value of the option

The value of the delta is determined using the Black and Scholes model. Delta is one of the outputs of this model. The dollar value of the contract is used to determine the value of Delta:

 

Silver Delta value (call option) Delta value (put option)
In silver. 0,6 – 1 -0,6 à -1
About money. 0.45 – 0.55 -0,45 à -0,55
We have no more money. 0 à 0,45 0 à -0,45

Delta put option : The delta of a put option is always negative. The value lies between -1 and 0. Let’s take an example of a situation. Suppose the spot price of Nifty is 9450. And the strike price in question is PE 9,500 (put option). The delta of this option is (-) 0.6 and the premium is 110.

Now, in scenario 1, if the spot price of Nifty increases by 80 points, then.

New spot price = 9530

Premium change = 80*(-.6) = -48 points

So, the new premium = 110-48 = 62. For put options, the premium falls if the spot price of the underlying asset rises (the premium and the spot price of a put option are negatively correlated).

If, in scenario 2, the spot price falls by 90 pips, then

New spot price = 9360

Premium change = 90*(-.6) = 54 points

New reward = 110+54 = 164 points

Risk profiling for delta selection

A trader’s ability to accept risk influences the choice of the appropriate execution price. It is always advisable to avoid trading options deep out of the money because the probability of these options expiring in the money is equal to their delta (5-10%). For a risk trader, the best strategy is to close contracts out of the money or in the money. A risk-averse trader should always avoid trading out-of-the-money contracts. They should always negotiate contracts with or in the currency, as the likelihood of a transaction turning out in their favour is much higher than for contracts outside the currency.

Gamma option

As we have seen, the option delta measures the change in the value of the premium relative to the change in the value of the underlying asset. The value of the delta also varies with changes in the value of the underlying asset. But how do you measure the change in delta value? We present to you GAMMA.

Gamma measures the change in the value of the delta relative to the change in the value of the underlying asset. Gamma calculates the delta gained or lost when the value of the underlying asset changes by one point. The important thing to remember here is that call and put spreads are positive. Let’s get one thing straight:

Nifty Cash Flow Course: 10000

Exercise price : 10100 CE

Match fee: 25

Delta option : .30

Gamma option : .0025.

Now, if the Nifty goes up 100 points, then…

New contribution = 25 + 100(.3) = 55

The change in delta is = change in spot price * gamma = 100*.0025 = .25

The new delta would be = 0.30 + 0.25 = 0.55 (the option is now an in-the-money contract).

Similarly, if the Nifty drops 70 points.

New contribution = 25 – 70(0.3) = 4

The delta change would be = spot price change * gamma = 70*.0025 = 0.175

The new delta would be = .30-.175 = .125 (the option is now a cashless contract).

Gamma Drive

The movement of the range fluctuates and varies with the movement of the contract money. As with delta, gamma movement is greatest for silver contracts and smallest for non-silver contracts. So ideally you should avoid selling/billing contracts for money. Out-of-the-money contracts are the best contracts to enter into because they are likely to expire worthless to the option buyer and the seller can pocket the premium.

Also read : Introduction to candlestick figures – Individual candlestick figures

Theta Option

Theta is an important factor in determining the price of an option. They use time as an ingredient in determining the premium for a given strike price. Time decay eats away at the option’s premium as expiration approaches. Theta is the decay factor in time, i.e. the speed at which the option premium loses value over time as expiration approaches.  As you know, the premium is simply the sum of the time premium and the intrinsic value.

Premium = time premium + intrinsic value.

Let us assume that the nifty spot is trading at 9450 and the strike price is 9500 CE (call option). Therefore, this option does not work at the moment. There are 15 days left until maturity and the premium for this option is 110. Now the intrinsic value (IV) of this option = 9450-9500 = -50 = 0 (since the IV cannot be negative).

Therefore, premium = present value + IV

=> 110 = time value + 0, so the time value of the out-of-the-money option is 110, i.e. the buyer is willing to pay a premium for the out-of-the-money option. Thus, the analogy between time and money also applies in the case of option pricing.

Another example:

  1. Suppose the maturity date is 15 days, the spot price of the stock XYZ = Rs. 95, base price = EC 100, premium = 5.5
  2. Now if the spot price XYZ = 96.5, the time to expiration = 7 days, for the same strike price, the premium drops to 3%.
  3. If the price rises to 98.5 with the same strike price and only 2 days before expiration, the premium falls to 1.75.
  4. So in the example above, the spot price moves towards the strike price, but the premium decreases as the time remaining until a significant move above the strike price decreases. It is less likely that the option will expire in-the-money. Greek theta is a friend of option sellers. It is advisable for option writers to sell an option at the beginning of the contract, as they may increase the amortization of the premium over time.

So the above example shows that the value of a premium decreases over time.

Variant of Vega

Because the Vega is Greek, it is sensitive to the current volatility. This is one of the most important factors in determining the price of an option. Volatility is, simply put, the rate of change. Vega simply means that the change in the value of an option is 1% of the change in the price of the underlying asset. The higher the volatility of the underlying asset, the more expensive it is to buy an option, and vice versa for a lower volatility.

Suppose the spot price of XYZ on the 5th is Rs 250. May and the 270 call option is trading at a premium of 8.

Suppose the vega of the option is 0.15. And the volatility of XYZ is 20%.

 

Short note
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If the volatility increases from 20% to 21%, the option price is 8+0.15 = 8.15

If volatility falls to 18%, the option price falls to 8 – 2(0.15) = 7.7.

Main outputs

When options team up, there are several players – the Greeks of the options such as Delta, Gamma, Theta, Vega, Volatility, etc. Each Greek plays its own key role in determining the exact price of an option. Each Greek plays its own key role in determining the exact price of an option. They play an important role in determining the monetary value of an option.

A simple and clear understanding of all the Greeks will help you choose the right strike price and option strategy. Risk management for options writers can be achieved through a better understanding of Greeks. Option buyers should ideally avoid trading out-of-the-money options and option sellers should ideally sell out-of-the-money options.

Hitesh Singhi is an active derivatives trader with over 10 years of experience in trading futures and options on Indian equities and international energy commodities like Brent, WTI, RBOB, gasoline etc. He has traded on BSE, NSE, ICE and NYMEX. Hitesh’s credits include a degree in business management and an MBA in finance. Follow Hitesh here on Twitter!You’ve heard of the Greeks, right? I bet you’ve heard of the Greeks, but don’t know what they are. They’re the ones who came up with a bunch of math ideas that are used in option trading. They were the first to figure out why options could be a good investment, and they are still used by option traders. They helped give the option a mathematical basis. But they’re not gods. They’re just people, just like you.. Read more about option greeks zerodha and let us know what you think.

Frequently Asked Questions

What are good Greek values for options?

The Greek values for options are: -Honesty -Responsibility -Integrity -Perseverance -Creativity -Initiative -Humility -Self-control -Sensitivity -Respect Honesty Responsibility Integrity Perseverance Creativity Initiative Humility Self-control Respect

What do the Greek symbols mean in options?

The Greek symbols in options are used to calculate the cost of the option.

How can I see Greeks in options?

Greeks are options that are used to measure the amount of risk associated with an option. Options that have a delta of 1.0 are considered to be at-the-money. Options that have a delta of 0.5 are considered to be half-way between the money and the stock. Options that have a delta of -1.0 are considered to be out-of-the-money.

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About the author

Trader Pit

A yogi who like Finance and Technology. I have been in Indian Stock market for over 12 years now as financial analyst, portfolio manager, trader. Now, I focus on Yoga, Financial Education & Long term investing. 

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