3.4 Introducing The Greeks

The Greeks provide traders with valuable insights into the behavior and risk of options contracts.

They are a set of parameters that help quantify the sensitivity of an option's price to various factors such as changes in the underlying asset price, time decay, implied volatility, and interest rates.

There are five main options Greeks that traders commonly refer to: Delta, Gamma, Theta, Vega, and Rho. Each Greek represents a different aspect of an option's nature and plays a crucial role in understanding how options behave.

Let's begin with the most important and basic of the squadron: Delta.

Delta measures the rate of change in the option price relative to changes in the underlying asset price.

Simply put, Delta tells us how much the option's value will change for a $1 move in the underlying asset price.

Gamma measures the rate of change in an option's Delta relative to changes in the underlying asset price.

In essence, Gamma indicates how much Delta itself will change for a $1 increase in the underlying asset price. So, Delta gauges the sensitivity of an option's price, while Gamma gauges the sensitivity of Delta.

Theta measures the rate of time decay in an option's value.

Along with Theta and the other Greeks, the concept of time decay will be covered more in-depth in Options Course 4: The Greeks. For now, all you need to know is that Theta gauges how much the price of an option will decrease as it moves closer to expiry.

This is because as time passes and an OTM option moves closer to it's expiration, the chances of the option expiring ITM become lower. The option becomes less valuable with time, assuming everything else stays equal.

Vega measures the sensitivity of an option's price relative to changes in implied volatility.

Simply enough, Vega tells us how much the option's price will change for a 1% increase in implied volatility.

Rho measures the sensitivity of an option's price to changes in interest rates. It indicates how much the option's price will change for a 1% change in interest rates.

Options Greeks provide valuable insights into the behavior of options, and understanding them thoroughly is crucial to trading options successfully. Analyzing the interplay between Greeks can also prove to be highly beneficial, not to mention applying the lessons learned to understanding the overall markets. So, let's recap: