{"id":569331,"date":"2023-03-16T13:23:41","date_gmt":"2023-03-16T11:23:41","guid":{"rendered":"https:\/\/www.etoro.com\/?page_id=569331"},"modified":"2024-08-19T14:49:28","modified_gmt":"2024-08-19T11:49:28","slug":"greeks-explained","status":"publish","type":"page","link":"https:\/\/www.etoro.com\/en-us\/options\/uk\/greeks-explained\/","title":{"rendered":"Options Trading 103: The Greeks, explained"},"content":{"rendered":"\n

What are the Greeks in options?<\/h2>\n\n\n\n

When trading options, the \u201cGreeks\u201d are an essential part of the experience. These metrics offer a window into the option contract\u2019s volatility and potential price changes over time. You can think of them kind of like the nutrition facts listed on food products. Traders use these to determine how healthy, mild, or spicy the contract is.<\/p>\n\n\n\n

There are four major Greeks we\u2019ll cover today (and a bunch of minor Greeks we\u2019ll leave for another time). Each Greek has its own function and, for lack of a better word, personality.<\/p>\n\n\n\n

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DELTA
\u201cThe Leader\u201d<\/h2>\n\n\n\n

This is arguably the most popular Greek. Think of Delta as the leader of a ragtag group of friends, out on the town and looking for fun.<\/p>\n\n\n\n

Delta tells you how much the price of an option will change if the underlying stock\u2019s price goes up or down $1.<\/p>\n\n\n\n

For example: Say the price of a call option is $5, the price of the stock is $150, and the Delta is 0.20. If the stock goes up to $151, the option price should increase to $5.20 (Delta + option price = new<\/i><\/b> option price).<\/p>\n\n\n\n

It\u2019s important to note<\/b>: the more the option is out of the money (OTM), the more Delta becomes a negligible metric.<\/p>\n\n\n\n

As time goes on, the Delta changes. It\u2019s important to note that put options have negative<\/i> Deltas.<\/p>\n\n\n\n

Aside from reading the Delta as the amount of money an option\u2019s price will increase or decrease, it\u2019s also widely seen as the probability that the option will expire in the money.<\/p>\n\n\n\n

If the Delta is 0.20, the option is seen as having a 20% chance of expiring in the money.<\/p>\n\n\n\n

These two ways of looking at Delta tell the option trader so much about how valuable the option is. That\u2019s why Delta is often seen as the most popular of the Greeks.<\/p>\n\n\n\n

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GAMMA
\u201cThe Sidekick\u201d<\/h2>\n\n\n\n

As Delta\u2019s right-hand man, Gamma focuses on Delta\u2019s expected rate of change.<\/p>\n\n\n\n

For example<\/strong>:<\/strong> If Gamma is 0.05 and Delta is 0.20, we will expect the next Delta change after<\/i> the first $1 increase to be an additional<\/i> 5 cents (Gamma). Watch it in action\u2026STOCK PRICE = $150<\/p>\n\n\n\n

STOCK PRICE = $150<\/p>\n\n\n\n

OPTION PRICE = $5<\/p>\n\n\n\n

DELTA = 0.20<\/p>\n\n\n\n

GAMMA = 0.05<\/p>\n\n\n\n

And then the stock increases $1\u2026<\/p>\n\n\n\n

STOCK PRICE = $151<\/b><\/p>\n\n\n\n

OPTION PRICE = $5<\/b>.20<\/b><\/p>\n\n\n\n

DELTA = 0.25<\/b><\/p>\n\n\n\n

GAMMA = 0.07<\/p>\n\n\n\n

Did you catch that? Gamma changed Delta, which will in turn change the price of the option once the stock price increases or decreases. It\u2019s like dominos \u2014 once one falls, they all do.<\/p>\n\n\n\n

Gamma is great because it\u2019s a predictor of the stability of Delta. Delta tells you how much the price of the option will change, but how do we know what happens after that $1 fluctuation? Gamma. It\u2019s what traders look at to see how stable the option price is when the stock price moves. With a Gamma of 0.05, that\u2019s pretty stable \u2014 no major price swings coming. But, Gamma gets higher for options that are in the money and closer to expiring. So keep your eye on Delta\u2019s shifty sidekick.<\/p>\n\n\n\n

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Theta
\u201cThe Naysayer\u201d<\/h2>\n\n\n\n

In every group, there\u2019s always that one person who bets against their success \u2014 the one always warning about the odds. They are the helpful voice of reason, grounding the excitable bunch. In options trading, Theta is that naysayer.<\/p>\n\n\n\n

Theta is almost always a negative number, and it represents how much value the option price is losing with time. (Implied Volatility can influence this, too \u2014 more on this below.)<\/p>\n\n\n\n

For example: A Theta of -0.10 means that your option\u2019s price will decrease by 10 cents every day.<\/p>\n\n\n\n

Theta is working against you \u2014 showing you how much you\u2019re losing every day, so you need to use the other Greeks to determine how much you stand to gain against<\/i> Theta. As an options contract gets closer to expiration, Theta tends to increase, a sign that your time is running out.<\/p>\n\n\n\n

It\u2019s important to note<\/b>: eToro Options currently doesn\u2019t support the ability to short an option<\/i>. However, if you were to short an option, Theta becomes your friend!<\/p>\n\n\n\n

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Vega
\u201cThe Wildcard\u201d<\/h2>\n\n\n\n

Vega is a bit of an outlier compared to the other three Greeks mentioned, in that it\u2019s directly impacted by a since unmentioned metric. That metric is called Implied Volatility <\/b>(symbol = \u03c3, aka sigma<\/i>). All options contracts will contain an implied volatility number. This number is calculated using a complex options pricing model, but it basically illustrates the price swings of the underlying stock. A high implied volatility means the price of the underlying stock is likely to make a sudden swing \u2014 either upward or downward. The opposite is also true \u2014 a low IV will mean the stock price probably won\u2019t increase or decrease all that much. It\u2019s important to note that probably and likely mean just that \u2014 they are not certainties.<\/p>\n\n\n\n

Vega estimates how much the price of the options contract will change with each percentage point change of implied volatility. Vega is always a positive number, the equation for using Vega generally looks like this: IV x Vega = Option price change.<\/p>\n\n\n\n

For example: XYZ stock\u2019s Implied Volatility increases by 2 and the Vega is 0.2, as a result, the value of the option should theoretically increase by $0.40 (Implied Volatility x Vega).<\/p>\n\n\n\n

That\u2019s why Vega is the wildcard of the bunch. They are operating off a different set of rules \u2014 uncertainty! But this is still a very important metric to look at when judging the potential \u201csuccess\u201d of an options contract.<\/p>\n\n\n\n

Cheat sheet:<\/span><\/p>\n\n\n\n

<\/div><\/div>
<\/div><\/div>
Delta<\/strong><\/td>\n
    \n
  • Probability that options will expire in the money.<\/li>\n
  • If a Delta is .40, it will increase 40 cents if the stock price increases by $1.<\/li>\n
  • It is also seen as having a 40% chance of expiring in the money.<\/li>\n
  • Put options have negative Delta values.<\/li>\n<\/ul>\n<\/td><\/tr>
Gamma<\/strong><\/td>\n
    \n
  • Rate of change for Delta.<\/li>\n
  • If a Gamma is .05 and Delta is .40, we will expect the next Delta change AFTER the first $1 increase to be an additional 5 cents. It\u2019s a way of predicting the future of Delta.<\/li>\n
  • Put options have negative Gamma values, and the lowest\/highest they can be is 0.<\/li>\n<\/ul>\n<\/td><\/tr>
Theta<\/strong><\/td>\n
    \n
  • Rate of decay over time.<\/li>\n
  • How much value is the option losing each day it gets closer to expiration.<\/li>\n<\/ul>\n<\/td><\/tr>
Vega<\/strong><\/td>\n