If you dig deep down into your high school memories,
you can probably uncover some facts about Greek mythology.
Like Zeus, the ruler of Olympus and all the gods.
Hades, lord of the underworld.
And all those other guys in between.
Well, those memories aren't so clear anymore.
But don't worry, today we'll focus on a different group
of Greeks--
the options Greeks.
Like the ancient gods, these Greeks
oversee certain domains--
including price, time, and implied volatility.
The Greeks are an important part of options trading,
as they tell you how changes in certain factors
may impact an options price.
So let's get to know them.
We'll start with Delta.
Like Zeus, Delta is the ruler over all the other options
Greeks, as it often has the biggest impact on an options
value.
Delta's domain is price.
It identifies how much the options premium may change
if the underlying price changes $1.00.
This means that an option with a Delta of 0.40 would be expected
to increase by $0.40 if the underlying rose $1.00.
Delta has another important use as well.
Some traders might use it to estimate an options probability
of expiring in the money.
For example, an option with a Delta of 0.40 can also be
interpreted as having a 40% chance of expiring
in the money.
The lower the Delta, the lower the odds
that the option will expire in the money.
One important thing to note about Delta
is that it doesn't have a constant rate of change.
It grows as an option moves further in the money,
and shrinks as it moves further out of the money.
To understand how this works, let's look at the next Greek--
Gamma.
Gamma is Delta's Hermes--
his right hand man in the price domain.
Gamma measures Delta's expected rate of change.
If an option has a Delta of 0.40, and a Gamma of 0.05,
the premium we expect it to change, $0.40,
with the first dollar move in the underlying.
Then, to figure out the impact of the next dollar move,
simply add Delta and Gamma together
to find the new Delta--
0.45.
Let's move on to Theta, the Greek of time decay.
Theta estimates how much value slips away
from an option with each passing day.
If an option has a Theta of negative 0.04,
it would be expected to lose $0.04 of value every day.
Remember, time decay works against buyers and for sellers.
Finally, there is Vega, whose domain is implied volatility.
Vega estimates how much the premium
may change with each one percentage point change
in implied volatility.
If an option has a Vega 0.03, and implied
volatility decreases one percentage point,
the premium will be expected to drop $0.03.
There are a lot of factors that could cause
a spike in implied volatility--
earning announcements, political conditions, and even weather.
Depending on the strategy you choose, a spike in volatility
could be a blessing, a curse, or have a very small impact.
And the further out an option's expiration
is, the higher its Vega will be.
In other words, options with a longer expiration
may react more to a change in the volatility.
Now, let's talk about the little brother of the options Greeks--
RHO.
RHO identifies how much an options premium may
move if interest rates change.
Because rates change slowly, they
have a smaller impact on options trading.
Like all little siblings, though, RHO
is often left out of the discussion about Greeks.
Nonetheless, RHO is still part of the family,
so he's worth mentioning here.
Now, let's pull our Greek council together,
and look at how they can be used to analyze the sensitivities
of a single option.
To set the stage, let's say your options premium is $1.30,
and your option has a Delta of 0.35, a Gamma of 0.06,
Theta of 0.02, and Vega of 0.07.
Today, price moves from $45 to $46,
and the premium increases $0.35 to $1.65.
Because a day has passed, the premium
decreases $0.02 due to Theta.
Tomorrow, price moves from $46 to $47.
The premium increases $0.41 to $2.04.
This is Delta plus Gamma.
Also, another day gone by means another day of time decay,
and another $0.02 down the drain.
Implied volatility rises one percentage point,
increasing the premium by $0.07 to $2.09.
Putting all these factors together
shows how a relatively small change in the underlying
could lead to a pretty significant change
in the options premium.
The option Greeks are a helpful crew to know.
They help you understand the impact various factors can
have on options trades.
You'll get to know them very well as you continue
your options education.
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