Option Greeks Explained

Option greeks explained

There are 5 types of option greeks. Once we know what are options then the next thing is how to use them. Option greeks are of utility for those people who are going to hold an option. Option Greeks are complicated in nature but once we have an understanding of them, it becomes super easy to select the strike price for trading. The option greeks are as follow

  • Delta Δ
  • Gamma γ
  • Theeta θ
  • Vega ν
  • Rho ρ

Definitions of Option Greeks

Delta in Option Greeks

Delta Δ denotes by what percentage the premiums of an option will change by 1 unit rise or fall in the prices of the underlying asset or Index. For CE delta are positive number from 0 to 1 and for PE it is negative between 0 and – 1 .

Example

  • 1 Bank Nifty current market price or spot price is – 35000 .
  • By looking at the market trend a trader feels that Bank Nifty will go up in next week she/he makes up her/his mind to buy a CE or call option
  • She/he decides to take a position on next week’s expiry to buy some time. Therefore she/he decides to trade on out of money call option. The strike price of option is 35800 CE which is trading at 100 Rs of Premium.
  • Finally before taking the trade she/he looks into Opstra’s or Sensibull’s Option Greeks.
  • The value of delta was 0.5151 in decimals and Rs 12.88 in terms of rupees. This means that if bank nifty goes from 35000 to 35001 the premium will go from 100 Rs to 100.5151. Consequently, there is a gain of 12.88 Rs for a single point movement in bank nifty from 35000.

Gamma in Option Greeks

Gamma γ denotes the rate of change of Delta Δ meaning for 1 unit of change in the underlying asset what will be the change in the value of Delta Δ. The value of gamma starts from 0 to 1 and can also be negative as well.

Example

Firstly, for our convenience we choose the same example as above.

  • Bank Nifty 35000
  • Strike Price 35800 CE
  • Premium 100 Rs
  • Delta 0.5151

Let us suppose the value of gamma is 0.0002. This means that for every 1 point change in bank nifty delta will change by 0.0002.

Lets say bank nifty goes from 35000 to 35300 change in points of bank nifty is 300. Then 300*.0002 = 0.0600. Delta will change from .5151 to 0.5751.

Theeta in Option Greeks

Theeta θ is the measure of time decay of an option. It is important to know if we are holding options in delivery. Just remeber the definition here, finally we will take an example to clear our doubts regarding all the option greeks.

Example

Firstly, for our convenience we choose the same example as above.

  • Bank Nifty 35000
  • Strike Price 35800 CE
  • Premium 100 Rs
  • Delta 0.5151
  • Gamma 0.0002

Once again let us suppose the value of theeta is -25. It means that if we hold an option of 35800 whose premium is 100 next day it will open with a premium of 100-25 = 75

Vega in Option Greeks

Vega ν is the measure of change in the volatility. There are many types of volatalities and a here is another beautiful post on Varsity by Zerodha on this topic for a better understanding of Vega with example

Rho ρ is the measure of change in premiums on 1% change in the interest rate. This greek is the least used among all the other greeks because interest rates do not change in a short span of time.

NOTE – In conclusion, even after having all the knowledge of the greeks one cannot trade options with safety. The reason for this is the image below. As per an article posted by investopedia the efficacy of the option is as good as the mathematical model they endorse.

Investopedia

Let us take an example and understand the greeks more carefully to have a holistic view by watching a video and taking a live example.

Share