Options are high-risk securities that are subject to constant price fluctuations. To control such unpredictable risks, you need specific mathematical tools that evaluate factors affecting the price of an options contract. These tools are known as Option Greeks.
There are five Option Greeks
- Delta
- Gamma
- Theta
- Vega
- Rho
Option Greeks are a set of metrics that measure how different factors influence the value of options. They help us better understand the risks of trading options and, more importantly, how to manage them. They also help decipher what causes an option to go up and down in value. These factors not only influence the option premiums on a minute-to-minute basis but also influence one another. Read the article as we elucidate the complexities of the Option Greeks; the terms that sound greek to many.
1. Delta
Delta calculates the rate of change in the option’s premium based on every unit change in the price of an underlying asset. This means that when the delta of an option is Rs 0.75, an Rs1 increase in the price of an underlying asset will increase the option premium by 0.75 rupees. Call options have a positive delta while Put options have a negative delta.
2. Gamma
Gamma is the rate of change with which delta fluctuates over time. A higher gamma indicates higher volatility, while a lower gamma indicates the stability of the delta. Hence, traders who look for predictable trade options do not go for a higher gamma. There is a positive Gamma for long options and a negative Gamma for short options.
3. Theta
With the passage of time, the chances of an option being profitable decrease. Theta represents the amount of option’s price that decreases easy day. This phenomenon is called time decay. Theta is always represented in a negative value since it indicates the price of an option going down. For instance, a theta of -0.02 means that the option will decline by Rs 0.02 per day.
4. Vega
Vega measures the risk of volatility that comes with the option in the future. It is different from delta since delta is focused on measuring present price fluctuations while Vega measures the expected volatility in the future. Vega helps one understand the sensitivity of an option during large price levels. Vega has a positive correlation with both Call and Put options; hence, an increase in Vega will lead to a price rise in both call and put options, and vice versa.
5. Rho
Rho calculates the option price change per one per cent change in interest rates. An increase in interest rates causes the value of the call option to increase and the value of put option to decrease. Hence, call options have a positive Rho while Put options have a negative Rho.
