ETF Trend Trading Option Basics Part Two The Greeks
Option Basics Separate Sections 1. Option Basics 2. The Greeks 3. Pricing 4. Types of Option Trades
The Greeks A simple perspective on the 5 Greeks 1. Delta 2. Gamma 3. Theta 4. Vega 5. Rho
The Greeks - Delta Delta is the measure of how an option will move with changes in the price of the underlying Easiest way to think of it is it is like owning stock (if I have a position with a delta of 70 the value of the position will move just like owning 70 shares of the underlying) Another way to think of it is the percent chance it will end up in the money Iif I have a position with a delta of 70 it has a 70% chance of finishing ITM at expiration
The Greeks - Gamma Gamma is the measure of how delta will change as the price of the underlying changes Options with positive gamma will gain delta as the underlying price moves up Options with positive gamma will lose delta as the underlying price moves down Options with negative gamma will gain delta as the underlying price moves down Options with negative gamma will lose delta as the underlying price moves up
The Greeks - Theta Theta is the measure of how quickly an option will lose its time premium ATM Options have the most Theta ITM options have less Theta than ATM Options OTM Options have less Theta than ATM options The further away a strike is from the ATM strike, the lower the Theta will be
The Greeks - Vega Vega is the measure of an options sensitivity to volatility changes For every 1% volatility increase in the underlying asset. The value of Vega is added to the value of an option For every 1% volatility decrease, the value of Vega is subtracted from an option
The Greeks - RHO Vega is the measure of how an option position will be affected by changes in interest rate Interest rates do not changed very often For short term options RHO is small and has no effect Interest rates and RHO have had little to no affect lately and will not be discussed any further
The Greeks A more detailed perspective on the 5 Greeks 1. Delta 2. Gamma 3. Theta 4. Vega 5. Rho
The Greeks Delta
The Greeks - Delta Delta is the measure of how an option will move with changes in the price of the underlying Easiest way to think of it is it is like owning stock (if I have a position with a delta of 70 the value of the position will move just like owning 70 shares of the underlying) Another way to think of it is the percent chance it will end up in the money Iif I have a position with a delta of 70 it has a 70% chance of finishing ITM at expiration
The Greeks - Delta Options with positive deltas will gain value when the underlying price increases Options with positive deltas will lose value when the underlying price decreases Options with negative values will gain value when the underlying price decreases Options with negative values will lose value when the underlying price increases
The Greeks - Delta Positive Delta Position Negative Delta Position Underlying Price Increases Options with positive deltas will gain value when the underlying price increases (i.e. if a option position has a position of +70 it will increase in value by $70 for every $1 increase in the price of the underlying) Options with negative values will lose value when the underlying price increases (i.e. if a option position has a position of -70 it will decrease in value by $70 for every $1 increase in the price of the underlying) Underlying Price Decreases Options with positive deltas will lose value when the underlying price decreases (i.e. if a option position has a position of +70 it will decrease in value by $70 for every $1 decrease in the price of the underlying) Options with negative values will gain value when the underlying price decreases (i.e. if a option position has a position of -70 it will increase in value by $70 for every $1 decrease in the price of the underlying)
The Greeks - Delta For each 1 point increase in the underlying price, the value of the delta is added to the value of the option ( if the delta is 80 and there is a 1 point increase in the underlying the new delta is 160) The delta of a call option is always positive (0-100) The delta of a put option is always negative (0 to -100)
The Greeks - Delta The value of an ATM call option will be approximately.50 The value of an ATM put option will be approximately -.50 As options go from ITM to ATM to OTM their deltas will decrease
The Greeks - Delta Calls Puts OTM Strike Prices Lower Deltas Delta s 0 to 50 Lower Deltas Delta s -50 to -100 ITM Strike Prices ATM Delta of approximately 50 Delta of approximately - 50 ATM Strike Prices ITM Strike Prices Higher Deltas Delta s 50 to 100 Higher Deltas Deltas -50 to 0 OTM Strike Prices
The Greeks - Delta Buy Calls If you buy calls you are getting long deltas Puts If you buy puts you are getting short delta Sell If you sell calls you are getting short deltas If you sell puts you are getting long deltas
The Greeks - Delta Delta and Time The further out in time we are looking the lower the delta will be Why is that? ---- The further out in time we are the less likely an option will end up in the money
The Greeks Gamma
The Greeks - Gamma Gamma is the measure (sensitivity) of how delta will change as the price of the underlying changes For each 1 point increase in the underlying price, the value of gamma is added to delta For each 1 point decrease in the underlying price, the value of gamma is subtracted from delta
The Greeks - Gamma Gamma impacts delta Options with positive gamma will gain delta as the underlying price moves up Options with positive gamma will lose delta as the underlying price moves down Options with negative gamma will gain delta as the underlying price moves down Options with negative gamma will lose delta as the underlying price moves up
The Greeks - Gamma Positive Gamma Position Negative Gamma Position Underlying Price Increases Options with positive Gamma will gain Delta when the underlying price increases (i.e. if gamma is.15 the Delta will increase by.15 with a $1.00 increase in the underlying) Options with negative Gamma will lose Delta when the underlying price increases (i.e. if Gamma is -.15 the Delta will decrease by.15 with a $1.00 increase in the underlying) Underlying Price Decreases Options with positive Gamma will lose Delta when the underlying price decreases (i.e. if gamma is.15 the Delta will decrease by.15 with a $1.00 decrease in the underlying) Options with negative Gamma will gain Delta when the underlying price decreases (i.e. if Gamma is -.15 the Delta will increase by.15 with a $1.00 decrease in the underlying)
The Greeks - Gamma Buy Calls If you buy calls you are getting positive gamma Puts If you buy puts you are getting positive gamma Sell If you sell calls you are getting negative gamma If you sell puts you are getting negative gamma
The Greeks - Gamma Gamma and Theta For positive Theta positions ( like Iron Condors) gamma is negative For negative Theta positions, Gamma is positive Gamma changes from negative to positive as the position approaches the break even points of our basic Monthly Theta positive income trades ( Iron Condors)
The Greeks - Gamma Gamma and Time Front month positions have more gamma than back month options at the same strike Gamma and ATM/OTM/ITM ATM options have the most gamma ITM and OTM option positions have less Gamma The further an option strike or position is from ATM the less Gamma it will have
The Greeks Theta
The Greeks - Theta Theta is the measure of how quickly an option will lose its time premium ATM Options have the most Theta ITM options have less Theta than ATM Options OTM Options have less Theta than ATM options The further away a strike is from the ATM strike, the lower the Theta will be
The Greeks - Theta OTM Strike Prices Calls Less Theta than ATM Puts Less Theta Than ATM ITM Strike Prices ATM More Theta More Theta ATM Strike Prices ITM Strike Prices Less Theta Than ATM Less Theta Than ATM OTM Strike Prices
The Greeks - Theta Long option positions are Theta negative positions ( They lose value each day) If you buy a call it is Theta negative If you buy a put it is Theta negative Short option positions are Theta positive (They gain time value each day) If you sell a call it is Theta positive If you sell a put it is Theta positive
The Greeks - Theta Buy Calls Theta Negative Lose value every day Puts Theta Negative Lose value every day Sell Theta Positive Gain value every day Theta Positive Gain value every day
The Greeks - Theta Theta and Time Value / Decay 90 Days 45 Days 30 Days Expiration 45-30 days from expiration the time curve starts to get very steep The closer we get to expiration the steeper the time curve
The Greeks - Theta Theta and Time For each day that passes the value of + theta is added to the value of the option ( your option position goes up in value) For each day that passes the value of - theta is subtracted from the value of the option ( your option position goes down in value)
The Greeks - Theta Theta and Time For longer term option positions theta decay is slower Shorter term option positions have faster theta decay An option with 30 days to expiration has faster / larger theta decay than an option at the same strike with 90 days to expiration
The Greeks - Theta Theta and Time Premium (Extrinsic Value) For longer term option positions Time Premium is higher than shorter term options of the same strike ( the longer time frame has more time value) Shorter term option positions have less Time Premium than longer term options of the same strike price ( it has less time value) ATM Options have higher Time Premium than OTM or ITM Options (the same holds true for Theta)
The Greeks Vega
The Greeks - Vega Vega is the measure of an options sensitivity to volatility changes For every 1% volatility increase in the underlying asset. The value of Vega is added to the value of an option For every 1% volatility decrease, the value of Vega is subtracted from an option
The Greeks - Vega Buy Sell Calls If you buy calls you are getting positive Vega (Increase the Vega of your position) If you sell calls you are getting negative Vega (Decrease the Vega of your position) Puts If you buy puts you are getting positive Vega (Increase the Vega of your position) If you sell puts you are getting negative Vega(Decrease the Vega of your position)
The Greeks - Vega Long Option Positions Implied Volatility Increases Vega Increases Value of long option positions increase Implied Volatility Decreases Vega Decreases Value of long option positions decrease Short Option Positions Vega Decreases Value of short option positions decrease Vega Increases Value of Short option positions increase
The Greeks - Vega What Else ATM options have the most Vega The impact of volatility changes is greater for ATM option positions than for ITM or OTM positions The impact of volatility changes is greater for far month options than for near month options Vega moves the opposite of Gamma and Theta as expiration approaches
Option Basics Primary Risk of Options Primary Risk of Options a primary risk you encounter with all options is time risk because option contracts have a limited life (they expire) Stocks and ETF s do not expire unless the company ceases to exist or the ETF is closed out by the managing firm