GREEK OPTIONS
FINANCIAL DERIVATIVE STRATEGIES
Delta
Delta measures the rate of change of option value with respect to changes in the underlying asset's price. Delta is the first derivative of the value of the option with respect to the underlying instrument's price .
Practical use
For a vanilla option, delta will be a number between 0.0 and 1.0 for a long call (and/or short put) and 0.0 and 1.0 for a long put (and/or short call) depending on price, a call option behaves as if one owns 1 share of the underlying stock (if deep in the money), or owns nothing (if far out of the money), or something in between, and Rho,[4] conversely for a put option. The difference of the delta of a call and the delta of a put at the same strike is close to but not in general equal to one, but instead is equal to the inverse of the discount factor. By putcall parity, long a call and short a put equals a forward F, which is linear in the spot S, with factor the inverse of the discount factor, so the derivative dF/dS is this factor.
Gamma
Gamma, measures the rate of change in the delta with respect to changes in the underlying price. Gamma is the second derivative of the value function with respect to the underlying price. All long options have positive gamma and all short options have negative gamma. Gamma is greatest approximately at-the-money (ATM) and diminishes the further out you go either in-themoney (ITM) or out-of-the-money (OTM). Gamma is important because it corrects for the convexity of value.
Practical use
When a trader seeks to establish an effective delta-hedge for a portfolio, the trader may also seek to neutralize the portfolio's gamma, as this will ensure that the hedge will be effective over a wider range of underlying price movements. However, in neutralizing the gamma of a portfolio, alpha (the return in excess of the risk-free rate) is reduced.
Vega
measures sensitivity to volatility. Vega is the derivative of the option value with respect to the volatility of the underlying asset. The symbol kappa, is sometimes used (by academics) instead of vega (as is tau (), though this is rare). Vega is typically expressed as the amount of money per underlying share that the option's value will gain or lose as volatility rises or falls by 1%. Vega can be an important Greek to monitor for an option trader, especially in volatile markets, since the value of some option strategies can be particularly sensitive to changes in volatility. The value of an option straddle, for example, is extremely dependent on changes to volatility.
Theta
Theta measures the sensitivity of the value of the derivative to the passage of time (see Option time value): the "time decay." The mathematical result of the formula for theta (see below) is expressed in value per year. By convention, it is usual to divide the result by the number of days in a year, to arrive at the amount of money per share of the underlying that the option loses in one day. Theta is almost always negative for long calls and puts and positive for short (or written) calls and puts. An exception is a deep in-the-money European put. The total theta for a portfolio of options can be determined by summing the thetas for each individual position.
Value of an option
The value of an option can be analysed into two parts: the intrinsic value and the time value. The intrinsic value is the amount of money you would gain if you exercised the option immediately, so a call with strike $50 on a stock with price $60 would have intrinsic value of $10, whereas the corresponding put would have zero intrinsic value. The time value is the value of having the option of waiting longer before deciding to exercise. Even a deeply out of the money put will be worth something, as there is some chance the stock price will fall below the strike before the expiry date. However, as time approaches maturity, there is less chance of this happening, so the time value of an option is decreasing with time. Thus if you are long an option you are short theta
Rho
Rho measures sensitivity to the interest rate: it is the derivative of the option value with respect to the risk free interest rate (for the relevant outstanding term). Except under extreme circumstances, the value of an option is less sensitive to changes in the risk free interest rate than to changes in other parameters. For this reason, rho is the least used of the first-order Greeks. Rho is typically expressed as the amount of money, per share of the underlying, that the value of the option will gain or lose as the risk free interest rate rises or falls by 1.0% per annum (100 basis points).
