Options traders often refer to the delta, gamma, theta, and vega of their option positions. Collectively, these terms are known as the Greeks, and they provide a way to measure the sensitivity of an option’s price to quantifiable factors. These can be confusing when you first learn about trading options.
To provide you with a basic understanding of Options Greeks that all beginner traders should know, we’ll focus on Delta, Gamma and Theta.
Delta measures the sensitivity of an option’s theoretical value to a change in the price of the underlying asset. It indicates how much the value of an option should change when the price of the underlying stock rises by one dollar.
When looking at the options chain, call options have positive deltas and put options have negative deltas.
Gamma measures the rate of change in the delta for each one-point increase in the underlying asset. It is a valuable tool in helping you forecast changes in the delta of an option or an overall position. Gamma will be larger for at-the-money options and goes progressively lower for both in- and out-of-the-money options.
Theta is the measure of the time decay of an option. In other words, the dollar amount an option will lose each day due to the passage of time. For at-the-money options, theta increases as an option approaches the expiration date. For in- and out-of-the-money options, theta decreases as an option approaches expiration.
Theta is one of the most important concepts for a beginner options trader to understand because it explains the effect of time on the premium of the options purchased or sold. The further out in time you go, the smaller the time decay will be for an option.
The Greeks collectively influence one another and fluctuate as the stock price moves, therefore, affecting the option pricing as well as affect the profits you may or may not realize. This means that is is vital for options traders to understand how the Greeks affect their trading.
Whether you want to make a living trading options or just beef up your retirement fund, learn the language of Options Greeks with Rob Roy by joining Power Option Plays and see just how the Greeks affect option pricing when Rob reviews a list of top option stock candidates in each class.