Options Greeks

RAVI - IBA
 Delta
Deltais a theoretical estimate of how
much an options premium may change
given a $1 move in the underlying.
For an option with a Delta of .50, an
investor can expect about a $.50 move in
that options premium given a $1 move, up
or down, in the underlying.
For purchased options owned by an
investor, Delta is between 0 and 1.00 for
calls and 0 and -1.00 for puts
 Delta
For sold options, as the investor
essentially has a negative quantity of
contracts, we find that short puts
have a positive Delta (technically a
negative Delta multiplied by a
negative number of contracts);
short calls have negative Delta
(technically a positive Delta times a
negative number of contracts).
 Example
The XYZ 20 call has a .50 Delta and is trading at
$2 with XYZ stock at $20.50. XYZ rises to
$21.50.
The investor would expect that the 20 strike call
would now be worth around $2.50 as seen
below:
$1 increase in underlying price x .50 Delta =
$.50 anticipated change in option premium.
Original Premium: $2.00 + $.50 estimated
change = $2.50 estimated new premium after
$1 stock price increase.
 Example Contd.
With a $1 move down in XYZ, the investor would
expect to see this same 20 strike call option
decrease in value to around $1.50.
As the stock price rises and the call option goes
deeper-in-the-money, Delta typically approaches
1.00 because of the increased likelihood the option
will be in-the-money at expiration.
As expiration approaches, in-the-money-option
Deltas are also more likely to be moving slowly
toward 1.00 because at expiration an option either
has a Delta of either 0 or 1.00 with no time
premium remaining.
 Call Deltas range from 0.00 to 1.00 while put
Delta ranges from 0.00 to -1.00.
Remember long calls have positive Delta;
conversely short calls have negative Delta.
Long puts have negative Delta; short puts have
positive Delta.
The closer an option's Delta is to 1.00 or -1.00,
the more the price of the option responds (in
terms of dollars) to actual long or short stock
when the underlying moves.
Here is a quick chart for reference:
Calls havepositiveDeltas (as generated by
model)
Positive correlation to underlying stock price change
Stock price then call Delta tends to go up
Stock price then call Delta tends to go
Call Deltas range from 0 to +1.00
Puts havenegativeDeltas (as generated
by model)
Negative correlation to underlying stock price change
Stock price then put Delta tends to go
Stock price then put Delta tends to go
Put Deltas range from 0 to 1.00
 Gamma
How Delta is expected to change
given a $1 move in the underlying is
calledGamma.
An investor can see how the Delta will
affect an option's price given a $1
move in the underlying, but to see
how the Delta on that optionmight
changegiven the same $1.00 move,
we refer to Gamma.
 Gamma
Gamma will be a number anywhere
from 0 to 1.00. Since Delta cannot be
over 1.00, Gamma cannot be greater
than 1.00 either as Gamma
represents the anticipated change in
Delta.
 Looking at a hypothetical example, XYZ is
trading 50. The XYZ Jan 50 call is trading for
$2, has a Delta of .50 and a Gamma of .06.
Should XYZ go up to $51, an investor can
estimate that the 50 strike call will now be
worth around $2.50.
The new Delta of this 50 strike call at an
XYZ price of $51 should be around 0.56
(simply adding the Gamma of .06 to the old
Delta of .50).
 In other examples

For the purpose of adjusting Delta amounts, round

Gamma to two decimal places
A call has a Delta of .54 and Gamma of .0400 (.04)
Stock goes up $1
Delta will become more positive by the Gamma amount
New Delta value: .58
Another call has a Delta of .75 and Gamma of .
0340 (.03)
Stock is down $1
Delta will become less positive by Gamma amount
New approximate Delta value: .72
 Long options, either calls or puts,
always yield positive Gamma. Short
calls and short puts will have
negative Gamma.
Underlying stock positions will not
have Gamma because their Delta is
always 1.00 (long) or -1.00 (short)
and will not change.
 Positive Gamma means that the Delta of
long calls will become more positive and
move toward +1.00 when the stock price
rises, and less positive and move toward 0
when the stock price falls.
Long Gamma also means that the Delta of
a long put will become more negative and
move toward 1.00 if the stock price falls,
and less negative and move toward 0
when the stock price rises.
 For a short call with negative
Gamma, the Delta will become more
negative as the stock rises, and less
negative as it drops.
 Theta
Both long and short option holders should
be aware of the effects ofThetaon an
option premium.
Theta is represented in an actual dollar or
premium amount and may be calculated
on a daily or weekly basis.
Theta represents, in theory, how much an
options premium may decay per day/week
with all other things remaining the same.
 Theta ortime decay is not linear.
The theoretical rate of decay will
tend to increase as time to expiration
decreases.
Thus, the amount of decay indicated
by Theta tends to be gradual at first
and accelerates as expiration
approaches.
 Upon expiration, an option has no time
value and trades only for intrinsic value, if
any. Pricing models take into account
weekends, so options will tend to decay
seven days over the course of five trading
days.
However, there is no industry-wide
method for decaying options so different
models show the impact of time decay
differently.
 If a pricing model is decaying options
too quickly, current markets may
look too high when compared to the
models theoretical values, and if the
model is displaying the decay as too
slowly, the current markets may look
too cheap compared to your models
theoretical values.
 If XYZ were trading $50 and a 50 strike
call was trading at $3 with a Theta of .05,
an investor would anticipate that option to
lose about $.05 per day, all things being
equal.
If a day passed without a change in the
option price, then one of the other
variables must have changed. In most
cases, it must have been an increase in
implied volatility.
 If the option decreased more than $.05 an
investor might deduce that implied
volatility on that strike or product might
have dropped as well. And as expiration
approaches, it is likely Theta would
become increasingly negative.
At the end of the second to last trading
day, with one day left until expiration, the
Theta should equal the entire amount of
time value left in the option.
 Vega
Vegameasures an options sensitivity
to changes in implied volatility. Implied
volatility is measured in percentage
terms and is a key variable in pricing
models.
Implied volatility has no direct
correlation to actual past historical or
statistical volatility; rather it is a
measure of predicted future movement.
 Vega
Implied volatility tends to increase when
there is uncertainty or anticipated news,
while it tends to decrease in times of calm.
Some investors use a stocks historical
volatility as an indication of where the
implied volatility should be, but the market
is the ultimate determining factor of current
implied volatility levels.
Also, Vega and implied volatility can change
without any movement in the underlying.
 Vega measures the amount of
increase or decrease in premium
based on a 1% (100 basis points)
change in the implied volatility
assumption.
 Example Vega
For example, XYZ is trading at $50, a
call with 12 months until expiration has
an implied volatility of 30%, a Vega of .
15, and a current market value of $4.
If implied volatility were to instantly
rise 2% to 32%, the investor might
expect the option premium to increase
by: .15 X 2 = $.30 to around $4.30, all
things being equal
 Example Vega Contd.
A decrease in implied volatility by 5%
may result in the option losing
around: .15 X 5 = $.75 in value.
As we can see, changes in implied
volatility can have drastic effects on
an option price, probably second only
to underlying price in importance.
 Rho
Rhois the measure of an option's sensitivity
to interest rate changes.
Similar to Vega, interest rate changes impact
longer-term options much more than near-
term ones (see chart below).
Interest rates are used in pricing models to
take into consideration an options price based
on its hedged value, the idea that an
investor uses long or short stock to hedge (or
manage risk associated with) option positions.
 Rho
Rho is positive for purchased calls as
higher interest rates increase call
premiums. Conversely, Rho is
negative for purchased puts as
higher interest rates decrease put
premiums.
 Rho example
For example, interest rates are
currently 3.00% and Rho on a $100
call option is +.45, if interest rates
suddenly went to 4%, the premium
would rise by $.45.
Conversely, if Rho for the put was
-.45, the put premium would decline
by $.45 per share. Of course this
assumes the other pricing factors
remain constant.
 An investor might ask, Why do
interest rates impact option prices?
It has to do with the cost of carrying
the position over time.
Pricing models take into
consideration the cost of capital (or
proceeds from short sales) used to
offset risk.
 Reference Links
http://www.optionseducation.org/cont
ent/oic/en/strategies_advanced_conc
epts/advanced_concepts/understandi
ng_option_greeks/delta.html