Understanding the Options Greeks Can Prove Profitable

I am options educator. Aside from being a professional trader, and now a self-publisher running my company Gulfport Analytics Powered by Toms Trading Room, I have spent many years traveling the globe with an option education company I co-owned teaching people the concept of options trading and how I trade them.

One of the more intimidating subject matters taught was the ‘Greeks’.

Option “Greeks”

Option Greeks are all measures of the sensitivity of an option’s price to various factors. Though they provide insight into how different variables impact the option’s price, also known as the option premium, there are several other factors that establish the price or premium.

Even though they aren’t the only things that factor in to the price of options I feel it useful to know even the basics of the Greeks.

Delta: This Greek measures the sensitivity of the option’s price to changes in the price of the underlying asset; stock ETF, Crypto, etc.

For Call options the Delta will be shown as number in the range of 0 to 1 and for a Put option Delta will be shown as a number ranging from 0 to -1.

A Delta of 0.5 for example means the Call option’s price is expected to increase by $0.50 for the first $1 gain in the underlying asset’s price. A -0.5 Delta means on the first $1 move down in the stock the Put option will increase $0.50.

What if the underlying goes the wrong way than anticipated?

If a Put option has a delta of -0.5 and the stock goes up $1 the option will decrease by $0.50.  If a Call option has a Delta of 0.5 and the stock goes down $1 the call option will decrease by $0.50.

In, Out and At the Money Option Deltas

At-the-Money (ATM) Options: These options typically have a delta close to 0.5 for calls and -0.5 for puts.

In-the-Money (ITM) Options: These options have deltas closer to 1 (for calls) or -1 (for puts).

Out-of-the-Money(OTM):  These options have deltas closer to 0.

Lastly, on Delta. Delta can also be looked at as the probability that the option will expire in the money. For example, a call option with a delta of 0.7 has a 70% chance of expiring in the money.

Gamma: Measures the rate of change of Delta; with respect to changes in the underlying asset’s price.

Gamma indicates the stability of Delta and helps in assessing the risk of an option position. Many of my instructors and I at my previous company called Gamma the Delta accelerator.

Given my example above of a Call option with a Delta of 0.5. If it has a Gamma of 0.05 what does that mean for the options pricing given the underlying moves higher $1?

If the underlying asset price moves higher by $1 the initial change in the option’s price would be $0.50 (due to Delta).

The Delta itself will increase by 0.05 (due to Gamma). The new Delta will be 0.55.

Then on the next $1 move in the underlying, the option’s price change will be adjusted based on the new Delta of 0.55.

Theta: This Greek measures the sensitivity of the option’s price to the passage of time, also known as time decay.   You may hear the term Theta Decay.  Theta Decay or Time Decay; same thing.

Theta shows how much the option’s price will decrease as it approaches expiration so long as all other factors remain the same.

Theta is usually expressed as a negative number for long positions. It indicates the amount by which the option’s price decreases each day that goes by.

Example: If an option has a Theta of -0.05, it means the option’s price will drop by 5 cents each day.

It’s helpful to know that if the underlying you are long an option on just sits there going sideways, basically, the option price decreases. And you know by how much each day it does nothing.

There are options strategies that can use Theta or Time Decay to their advantage and be profitable due to the passage of time and the stock really not going in any direction, but that is education for another day.

Vega: Vega measures the sensitivity of the option’s price to changes in the volatility of the underlying asset.

Vega tells you how much the price of an option is expected to change with a 1% change in the underlying asset’s volatility. Example: if an option has a Vega of 0.10, and the implied volatility increases by 1%, the option’s price would increase by $0.10.

Volatility of the underlying assets price can be affected by Market volatility.  Market volatility can be caused by economic reports and earnings announcements to name a couple factors. Don’t be surprised if down the line I introduce you to options trading strategies based on an expected rush in volatility going into an earnings announcement.

Rho: Measures the sensitivity of the option’s price to changes in interest rates. Rho shows how much the option’s price is expected to change with a 1% change in interest rates.

As I end this Education for now, much of my focus is on Delta.  I like to trade options with the goal of getting a double on my money.

If I go long a call option at $3.00 I want to eventually close the option at $6.00.  That is a gain of $3.00 or 3-points.

In a pure basic view from the education I gave if that option has a Delta of 0.7 (and I am not even going to use Gamma, or any other Greek) I can say that stock needs to go at least 5-points higher to potentially get that 3-points.

5-points multiplied by that 0.7 Delta or $0.70 per point or dollar higher = 3.5-poins or $3.50 in gains.

Factor in at least the Gamma and what it does to increase the Delta on each dollar move higher in this example, and the stock may be able to get that double with less than a 5-point higher move.

It will take time to understand the “Greeks” and how they work without having to rack your brain on each option trade.

I contend it is time well spent, because knowing the “Greeks” will help you know ahead of time what to expect regarding potential gains and managing potential losses with your options trading.

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