What are the Greeks?
The terms "Greeks" is commonly used in options trading to describe the scale of risk involved in an options position. The variables are typically associated with Greek symbols such as Delta, Gamma, Theta and Vega, hence the name. Each variable considers the relationship of the option with another underlying variable.
- TLDR: ‘Delta’ indicates how much your option may increase/decrease in value given a $1 price change in the underlier.
- Generally, options do not move one to one with the underlier, unless they are well in-the-money. Delta will indicate how your option contract may move given a change in the underlier’s value.
- Call options have positive Deltas, between 0 and 1. A Delta of .5 would indicate that, for every $1 the underlier goes up, the option value will increase by $.50.
- Put options have a negative Delta, between 0 and -1. A Delta of -.5 on a long-put contract would indicate that for every $1 the underlier decreases in value, the option value will increase by $.50.
- Keep in mind, these relationships shift over time, as does the Delta of your positions.
- Generally speaking, options closer to at- or in-the-money will move more given a change in the underlier compared to options that are out-of-the-money. Therefore, they will have a higher Delta.
- TLDR: Gamma indicates how much the Delta will change given a $1 move in the stock price.
- Generally, Gamma is highest for at-the-money options contracts. This means that Delta is most sensitive to changes in the underlier’s price when a contract is at-the-money. A Gamma of .10 would indicate that for a $1 change in the underlier, the Delta would change by .10.
- TLDR: Theta represents the fall (decay) in an option’s value due to the passing of one day.
- From the perspective of a long options holder, Theta tends to reduce (decay) the value of your position as time elapses. For a short option holder, Theta tends to increase the value of your position.
- A Theta value of -.20 would indicate that, all things being equal, a long option holding will decrease by $.20 per day. However, it is important to note that Theta is not constant over the lifetime of the option. For example, as an at-the-money option gets closer to its expiration date, Theta tends to increase, and the value lost to time decay accelerates.
- TLDR: Vega represents the sensitivity of an options contract to changes in implied volatility, holding all other factors constant. (See below for more detail on implied volatility)
- Vega estimates the value a call or put option will change given a 1-point change in Implied Volatility (see above for definition of implied volatility).
- Typically, as Implied Volatility increases, the value of a long options contract also increases. The opposite holds true for a short position, where increasing Implied Volatility generally decreases the value of your holdings.
- A Vega of .05 would indicate that, given a 1-point increase in Implied Volatility, the value of a long option would increase by $.05.
- TLDR: Implied Volatility is a measure of how much the market anticipates the underlier to move.
- Higher Implied Volatility generally means a more expensive option. This doesn’t necessarily mean you will make more or less, just that the market is anticipating larger pricing moves in the underlier. You should consider whether you think Implied Volatility is fairly priced, based on your own research.
How changes to Implied Volatility may impact your holdings:
- If you hold long options contracts, and volatility increases, your option will generally gain in value. Conversely, if you hold short options, and volatility increases, your position will generally lose value.
- There are times when a change in Implied Volatility can outweigh the directional move of the underlier. For example, you may have a long call, and the underlier increases in value, but your call option loses value due to decreased Implied Volatility.
- Different options are more or less sensitive to changes in Implied Volatility. Generally, short-dated options are less sensitive to a change in Implied Volatility and longer-dated options are more sensitive. Options with strikes that are closer to being at-the-money are also usually more sensitive to changes in Implied Volatility.
** This FAQ is for educational purposes only and is not a solicitation or recommendation to invest in any security. Accuracy of the above information is not guaranteed. It is expected that users will do their own research outside of Gatsby when making investment decisions. See full disclosures at trygatsby.com.