Like other underlying assets, options come with a risk. In order to know your risk level, you need to look at the Greeks. These are a set of measurements that tell you a lot about the risk factor of your option. Let’s dig into what each of the Greeks is telling you.
What Are Options?
Options are contracts that give you the right to buy or sell a stock at a set price within a specific timeframe. When they reach their expiration date, you may no longer exercise these rights. Options are often helpful because they can enhance your portfolio and you are not obligated to exercise your rights.
The two types of options are calls and puts. Calls are when you have the right to buy, and puts are when you have the right to sell. You can determine which kind of option to hold based on the anticipated direction of a stock.
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Delta tells you how you can expect the price of an option to change per $1 price change of the underlying security or index. For instance, if you see a delta of 0.55, you can assume the price of an option will move 0.55 for every $1 movement of an underlying stock or index’s price. The range of delta depends on whether you have a call or put option. The range for a call option is 0.0 to 1.00, while the range for a put option is 0.0 to -1.00.
Gamma has a direct relationship with delta, as it indicates the rate of change of delta. This is helpful since delta only tells you where an option sits for a specific moment. Gamma measures how much the delta of an option may change as the price of an underlying stock or index rises or falls.
Theta is a measurement that can tell you the risks of options trading when it comes to time decay. It tells you how much an option’s price is likely to decrease each day as it gets closer to the expiration date. Generally, you can assume that options lose value each day they mature. This is true especially in cases where every other variable is constant until the expiration date. Theta can help you decide how long to go before buying or selling your option.
Vega measures how sensitive an option is to volatility. It tells you the rate of change in the price of an option per 1% change in the underlying stock’s implicit volatility. Although vega isn’t a true Greek letter, it is grouped with the Greeks since it tells you about an option’s risk. When the vega of an option drops, you can expect both call and put options to lose their value. If it increases, both types of options tend to gain value.
Using the Greeks to assess your risk level is an important part of being a successful options trader. By truly understanding what each one indicates, you can have a better concept of your risk.