What are the Option Greeks

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• What are the Option Greeks

• Option Greeks explained
• Author Hari Swaminathan

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About OptionTiger

• If youre somewhat new to Options, you must have
  heard about the Option Greeks. In fact, a common
  rookie mistake with Options traders is that they
  ignore the Greeks. In this post, hopefully, I can
  convey the importance of Option Greeks
  explained in simple terms. This is easily one of
  the biggest mistakes a newbie Options trader can
  do. 
•  
• Youll find the Option Greeks explained in many
  complicated ways youll find common
  explanations for Delta as the amount an Option
  price will change for a 1 move in the
  underlying, and youll find similar explanations
  for the other 3 main Greeks as well Gamma,
  Theta and Vega. Let me try a slightly different
  explanation here.
•  
• You are an airline pilot
• Put yourself in the shoes of an airline pilot. A
  pilot needs two sets of tools to fly the plane
  safely from Point A to Point B. 
• 1) The pilot needs a map to know where to go.
• 2) The pilot also needs a set of reliable
  instruments to get from A to B.

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• In the Options world, the map is the Profit
  Loss diagrams, and various Options simulation
  tools you have including the simulation of risk
  graphs. You look at the risk graph and you get a
  visual idea of where you need to go. You tweak
  the simulation parameters to know how your
  position will perform under different market
  conditions like Price movement, changes in
  Volatility or with the passage of time. You can
  tweak one or all of these parameters and you can
  see how these simulations impacts your Risk
  Graph. This is the Map. Its visual. And you get
  a clear visual idea of how to navigate your trade
  by mentally setting various adjustments, and even
  the nature of adjustments. 
• The second tool is a reliable set of instruments
  that can get the plane from A to B. In the
  Options world, this set of instruments are your
  Option Greeks. Think of the four main Greeks as
  the set of four key instruments available to you
  as the pilot of your Options trade. If one of
  these instruments has overshot some
  pre-determined limits, you have to turn its knob
  to one side to bring it back into the acceptable
  limits. You do this for all four Greeks in an
  effective manner, and youre actually guiding
  your plane safely to your destination. This
  analogy is very true You can control every
  aspect of your Option position simply by tweaking
  the four Greeks. You dont even need to look at
  what the markets or your stock is doing. You can
  manage your adjustment points, and once you
  become an expert, you can navigate your Options
  plane on auto-pilot. Hopefully, you have a
  better appreciation for how important Option
  Greeks are. 
•  

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About OptionTiger

• But what exactly are the Option Greeks ? What do
  they measure ? And why is it the case that these
  obscure terms can have such control on whats
  going on in the markets ?
•  
• The key lies in the fundamental facts about what
  Options are, and how the Black Scholes Options
  pricing model was invented.  Youve probably
  heard before that Options are a mathematical
  concept. Buyers and sellers barter rights and
  obligations. There is no underlying security that
  is actually traded, you only trade contracts with
  rights and obligations that are based on an
  underlying security like shares of a stock. All
  Options also have an expiry date of some time in
  the future. Options do cost money, so there is a
  cost of carry of these rights and obligations.
  The opportunity cost of this capital is dependent
  on the prevailing interest rate environment. And
  because Options have an expiry date, they must
  lose some value as time passes. And once again,
  because of this expiry date, you have to ask this
  question Within a certain amount of time, what
  is the probability of a certain stock reaching a
  certain price (strike price of the option). To
  answer this question on probability, you need to
  know the Volatility of the stock, with
  Volatility being defined in standard deviation
  terms based on that stocks historical stock
  prices (say past 12 months).

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• So pricing an Option has to consider all these
  elements. The inventors of the Black-Scholes
  formula had to consider all these elements.
  (Notice I used the word formula in this
  sentence). And this is the key. Everything in
  Options pricing is a formula. The way an Option
  responds to price movement of the underlying
  stock is a formula. The way it responds to
  passage of time is a formula. The way it responds
  to changes in Volatility is also a formula and so
  on and so forth with interest rates, cost of
  capital etc. So everything is a formula. Options
  are a truly mathematical concept, and the price
  of an Option has many components to it, and each
  of its components responds to one or more of
  these parameters. 
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• In the case of response to changes in the
  underlying price of the stock the Greeks are
  Delta and Gamma
• Sensitivity to the passage of time is measured
  by the Greek Theta.
• Sensitivity to changes in Implied Volatility is
  measured by Vega. 
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• Interest rates is Rho..and so on.

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About OptionTiger

• And each one of these Greeks are calculated by a
  formula from the Black Scholes model. Because of
  this fact, we can manage the entire options
  position simply by managing the Greeks. Imagine
  yourself looking down upon an instrument panel
  with these four main instruments. And in front of
  you is the market, but youre not looking at the
  market because youre looking down at your
  instrument panel which is getting a real-time
  feed of whats going on in the markets, by way of
  changing Option prices. The Greeks are changing
  because of the change in Option prices, and all
  youre doing is managing your Greeks, and
  navigating your trade to success. You can be
  oblivious of everything else. Thats how
  powerful Option Greeks are.

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