Learning the Option Greeks

Posted on Thursday, September 5, 2019 at 2:26 PM

As summer comes to a close here in Chicago, I have spent more than the usual amount of time over the past few weeks reviewing the option greeks in our Group Coaching class. It is always important to know about the greeks when trading options, but many traders neglect to properly educate themselves. It has been a couple of years since I last talked about them as a whole, so I thought it would be a great time to review them for those who are still struggling. For the first part of this reference guide, let’s talk about what is positive and what is negative and what that really means for an option trader. Let’s begin with delta.

Delta

Option delta measures how much the option price should change based on a $1 move. Simply put, for every dollar the underlying moves higher or lower, the premium should change by that amount. Long calls and short puts have positive deltas. This means the position can profit if the stock moves higher. Keeping it simple, a long call can profit if the stock moves higher because the right to buy the stock becomes more valuable and a short put becomes less valuable with a move higher allowing the trader to potentially buy back the put for less.

Short calls and long puts have negative deltas. The position can profit if the stock moves lower. A long put can profit because the right to sell the stock becomes more valuable with a move lower and a short call becomes less valuable. The seller can potentially buy back the short position for less than what it was sold for.

Gamma

Option gamma measures how much delta should change based on a $1 move. Keeping it simple once again, gamma changes the delta based on a dollar move higher or lower. Negative or positive gamma confuses many option traders, but it is fairly simple to understand. Long options, both calls and puts, have positive gamma and short options have negative gamma.

Simply said, positive gamma increases the delta when the stock moves in the intended direction and lowers the delta when the stock moves against you. Negative gamma increases the delta against you when the stock moves against the position and decreases the delta when the stock moves in the intended direction.

Theta

Option theta measures how much the option price will decline due to the passage of time. For every day that passes, the option price should decrease by the theta amount. Long options, both calls and puts, have negative theta. Short options, both calls and puts, have positive theta. The thing to remember is that options are always losing value due to time. If an option has positive theta, the passing of time benefits the position. If the position has negative theta, time passing hurts the position.

Vega

Option vega measures how much the option price will change due to changes in implied volatility (IV). For every 1% change in IV, the option price should change by the amount of vega. Like gamma, long options, both calls and puts, are said to have positive vega. An increase in implied volatility will benefit the position and vice versa. Short options, both calls and puts, are said to have negative vega. A decrease in implied volatility will benefit the position and vice versa.

Lead Dog

Many option traders trade spreads. This is where the “lead dog” comes into play. Option traders need to add up the long greeks and short greeks, and whichever one is bigger for that particular greek becomes what I like to call the lead dog. For example, if you have a long call with a gamma of positive 0.03 and a short call with a gamma of negative 0.05, the position would have a negative gamma of 0.02 (0.03 – 0.05). If the delta on the position was positive 0.10 and the stock moved a dollar higher, the new delta would be positive 0.08 (0.10 -0.02).

I hope this clarifies a few things for you. The key to getting more familiar with the greeks is repetition. Quiz yourself often as I do in my class and over time, you can be an options greek guru.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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