If you have heard your stock broker or advisor use the terms ‘gamma’, ‘delta’, ‘theta’, ‘rho’ or ‘vega’ to determine positions, then don’t rush up to enroll for Greek lessons! View the presentation to know what they mean.
No, You Don’t Have to Learn Greek to Understand Options Trading!
No, You Don’t Have to Learn Greek to
Understand Options Trading!
Predicting the price of an option
Predicting the movements of options is not that easy. It is not just the
price of the underlying asset; but there are many other factors that
contribute to the movement of the price of an option.
Changes and their impact
The overall outcome of the option positions are a result of the changes
in the market positions. There are several factors that determine the
price of an option and this helps one determine the impact they have.
No need to know Greek!
If you have heard your stock broker or stock advisor use the terms
‘gamma’, ‘delta’, ‘theta’, ‘rho’ or ‘vega’ to determine positions, then don’t
rush up to enroll for Greek lessons!
It’s a fairly simple concept that quantifies the sensitivity of the option
positions. Ideally, the Greek terms that are used, usually denote the risk of
the option and the reward that can be expected from that position.
What are option Greeks?
Commonly known as Option Greeks, it revolves around the study of
picking out the right Option for the right price. These Greeks give an
indicative price to arrive at a target price to incur profits and also to arrive
at when to minimize losses by giving up a position.
This Greek has a direct relationship with the movements related to the
underlying share price or index. In other words, it helps us understand
whether an option price is going to change because of the change in the
underlying asset (which is an index of the stock). So, if we assign delta for
an option price as 0.15, then the change in the underlying price of the
stock by Re. 1 would indicate an increase in the Call option by 0.15.
This is the rate of change in the delta for every change in the underlying
price. In this case, if there is a change in the delta by an increase of Re. 1
in the underlying price of the stock, then the rate at which the delta has
changed is measured.
As the value of an option reduces, it comes closer to its expiry date. Theta
helps measuring the gradual change in the option as it approaches its
expiry date or comes closer towards the zero value. With this, the theta
measures the effect of the passage of time on the option price.
The overall impact of volatility on the Option price is measured by Vega.
The implied volatility directly affects the option price making it rise and fall.
Hence, if the implied volatility of the stock increases, then it is likely that the
option price will also increase and vice versa if it declines.
Rho measures the impact of the overall interest rates on the option price.
This is not always measured, as the impact on the option price is minimal.
It’s important to also note that Option Greeks cannot be easily calculated
by anyone, it requires several advanced mathematical calculations. These
are not easily found in the daily newspapers. One can find an Options
calculator within financial websites; these have the fields such as spot
price, time of expiry and other factors that govern the calculation of delta,
gamma, theta, vega and rho.
To learn more about Options
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