Option Greeks
Option Greeks are metrics used to more precisely understand the behavior of an option’s price. In a nutshell, they measure the sensitivity of an option’s price in relation to several different factors. Those factors include underlying stock price, interest rate, volatility, and time decay.
Traders use Option Greeks to analyze changes in the price of options in their portfolio. Basically, the Greeks allow the traders to determine what is affecting the price of their options.
Knowing how the Option Greeks function gives traders the ability to understand and construct options positions with specific risk/reward characteristics. It also allows them to properly hedge their positions against certain risks if they choose to do so.
The 5 Options Greeks are Delta, Gamma, Theta, Vega, and Rho:
- Delta is a measure of an option’s sensitivity to changes in the price of the underlying asset.
- Gamma measures the sensitivity of delta to changes in the price of the underlying asset.
- Vega is a measure of an option’s sensitivity to changes in the volatility of an underlying asset.
- Theta measures an option’s sensitivity to time decay.
- Rho is a measure of an option’s sensitivity to changes in interest rates.
Professionals use Option Greeks extensively, particularly for risk management purposes. For amateurs, it’s important to at least understand the impact of the different variables on an option’s price.
Moreover, amateurs should at minimum become familiar with Delta and Theta. These two variables are invaluable for understanding the day to day movement of option prices.
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Category: Options Trading
