SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Options Greeks: Is it Greek to You?


Trading options without understanding Options Greeks is like flying a plane without the ability to read instruments. Unfortunately, many traders do not know how to read the Greeks. This puts them at risk of a fatal error, much like a pilot would experience flying in bad weather without the benefit of a panel of instruments at his or her disposal.

In this article, I will try to help you understand Options Greeks and use them to your advantage.

 

The Basics

 

Options Greeks: Is It Greek To You

 

First, a quick reminder for those less familiar with the Options Greeks.

 

The Delta is the rate of change of the price of the option with respect to its underlying price. The delta of an option ranges in value from 0 to 1 for calls (0 to -1 for puts) and reflects the increase or decrease in the price of the option in response to a 1 point movement of the underlying asset price. In dollar terms, the delta is from $0 to +$100 for calls ($0 to -$100 for puts).

 

Delta can be viewed as a percentage probability an option will wind up in-the-money at expiration. Therefore, an at-the-money option would have a .50 Delta or 50% chance of being in-the-money at expiration. Deep-in-the-money options will have a much larger Delta or much higher probability of expiring in-the-money.

 

The Theta is a measurement of the option's time decay. The theta measures the rate at which options lose their value, specifically the time value, as the expiration draws nearer. Generally expressed as a negative number, the theta of an option reflects the amount by which the option's value will decrease every day. When you buy options, the theta is your enemy. When you sell them, the theta is your friend.

 

Option sellers use theta to their advantage, collecting time decay every day. The same is true of credit spreads, which are really selling strategies. Calendar spreads involve buying a longer-dated option and selling a nearer-dated option, taking advantage of the fact that options expire faster as they approach expiration.

 

The Vega is a measure of the impact of changes in the Implied Volatility on the option price. Specifically, the vega of an option expresses the change in the price of the option for every 1% change in the Implied Volatility. Options tend to be more expensive when volatility is higher. When you buy options, the vega is your friend. When you sell them, the vega is your enemy.

 

Short premium positions like Iron Condors or Butterflies will be negatively impacted by an increase in implied volatility, which generally occurs with downside market moves. When entering Iron Condors or Butterflies, it makes sense to start with a slightly short delta bias. If the market stays flat or goes up, the short premium will come in and our position benefits. However, if the market goes down, the short vega position will go against us - this is where the short delta hedge will help.

 

The Gamma is a measure of the rate of change of its delta. The gamma of an option is expressed as a percentage and reflects the change in the delta in response to a one point movement of the underlying stock price. When you buy options, the gamma is your friend. When you sell them, the gamma is your enemy.

 

Selling options with close expiration will give you higher positive theta per day but higher negative gamma. That means that a sharp move of the underlying will cause much higher loss. So if the underlying doesn't move, then theta will kick off and you will just earn money with every passing day. But if it does move, the loss will become very large very quickly. You should never ignore negative gamma.

 

Example

 

Lets analyze the Greeks using one of our recent trades as an example:

 

Buy to open 4 ORCL July 17 2015 44 put
Buy to open 4 ORCL July 17 2015 44 call
Price: $2.66 debit

 

options greeks

 

This trade is called a straddle option strategy. It is a neutral strategy in options trading that involves the simultaneously buying of a put and a call on the same underlying, strike and expiration. A straddle is vega positive, gamma positive and theta negative trade. That means that all other factors equal, the straddle will lose money every day due to the time decay, and the loss will accelerate as we get closer to expiration.

 

With the stock sitting at $44, the trade is almost delta neutral. Lets see how other Greeks impact this trade.

 

The theta is your worst enemy as we get closer to expiration. This trade had 44 days to expiration, so the negative theta is relatively small ($3 or 1% of the straddle price). As we get closer to expiration, the negative theta becomes larger and the impact on the trade is more severe.

 

The gamma is your best friend as we get closer to expiration. That means that the stock move will benefit the trade more as time passes.

 

The vega is your friend. If you buy options when IV is low and it goes higher, the trade starts making money even if the stock doesn't move. This is the thesis behind our pre-earnings straddles.

 

Make them Work For You

 

If you expect a big move, go with closer expiration. But if the move doesn't materialize, you will start losing money much faster, unless the IV starts to rise. It basically becomes a "theta against gamma" fight. When you expect an increase in IV (before earnings for example), it's a "theta against vega" fight, and the large gamma is the added bonus.

 

When you are net "short" options, the opposite is true. For example, Iron Condor is a vega negative and theta positive trade. That means that it benefits from the decline in Implied Volatility (IV) and the time decay. If you initiate the trade when IV is high and IV is declining during the life of the trade, the trade wins twice: from the declining IV and the time passage.

 

However, it is also gamma negative and the gamma accelerates as we get closer to expiration. This is the reason why I don't like holding the Iron Condor trades till expiration. Any big move of the underlying will cause big losses due to a large negative gamma.

 

The gamma risk is often overlooked by many Condor traders. Many traders initiate the Iron Condor trades only 3-4 weeks before expiration to take advantage of a large and accelerating positive theta. They hold those trades till expiration, completely ignoring the large negative gamma and are very surprised when a big move accelerates the losses. Don't make that mistake.

 

One possible strategy is to combine vega positive and theta positive trades with vega positive and theta negative ones. This is what we do at SteadyOptions. A Calendar spread is an example of vega positive theta positive trade. When combined with a straddle trades which are vega positive theta negative, a balance portfolio can be created.

 

Conclusion: when you trade options, use the Greek option trading strategies to your advantage. When they fight, you should win. Like in a real life, always know who is your friend and who is your enemy.

 

The following videos will help you understand options Greeks:

 

 

Related articles:


We invite you to join us and learn how we trade our Greek options trading strategies. We discuss all our trades including the Greeks on our forum.

 

Start Your Free Trial

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • How To Create Your Own Indexed Annuity

    Indexed annuities are a life insurance company product sold by insurance brokers for a commission that is based on the amount deposited into the contract. Contract performance is linked to popular indexes like S&P 500, and early withdrawal penalties typically apply for the first 7-10 years if withdrawals greater than 10% of the contract value are taken each year.

    By Jesse,

    • 0 comments
    • 879 views
  • Q&A with Mental Game Coach Jared Tendler

    QUESTION: Thank you for taking the time to participate in a Q & A session with Steady Option. Let’s start with an introduction and a little bit of background on who you are and how you got here.

    By Jared Tendler,

    • 0 comments
    • 1,103 views
  • Using TLT Options to Increase Expected Returns of a Buy & Hold Portfolio

    TLT is the iShares 20+ Year Treasury Bond ETF that seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years. Even though US Treasuries typically act as a diversifying asset class to mainstream equities, many investors with long time horizons may not be interested in holding TLT in their portfolio because it would lower expected returns.

    By Jesse,

    • 0 comments
    • 1,316 views
  • Tax Efficient Trading Part II: Capital Gains Deferral

    In part I I illustrated how the preferential tax treatment of 1256 contracts could improve after tax returns of a PutWrite strategy over a long period of time. In this article, I’ll continue the illustration by switching from a PutWrite to an ETF BuyWrite (covered calls) strategy while holding pre-tax expected returns constant at 8%.

    By Jesse,

    • 0 comments
    • 1,619 views
  • Tax Efficient Trading Part I: The 1256 Contracts

    Cash settled index options like SPX, XSP, RUT and a few others receive special federal tax treatment where 60% of the gains are reported as a Long Term Capital Gain (LTCG) even if the contract was held for less than a year.

    By Jesse,

    • 0 comments
    • 1,604 views
  • SPY Short Puts vs. Put Spreads

    In this article I’ll be using the ORATS Wheel backtesting tool to compare the performance since 2007 of SPY short puts versus short put spreads. I’ll look at both risk and returns, and different ways of determining position size to adjust for the differences in risk between the two trades.

    By Jesse,

    • 1 comment
    • 2,410 views
  • Signs that you Are Ready to Start Investing

    If you want to build your wealth, you have to make sure that you invest your money. If you put money into a savings account and don’t earn any interest from it, this won’t work for you in the long term. Your money will lose value because of inflation, and this is the last thing that you need. So when do you invest?

    By Kim,

    • 0 comments
    • 1,735 views
  • One Year of Diversified leveraged Anchor

    I almost hate to keep saying it, but the Diversified Leveraged Anchor strategy keeps exceeding expectations and performing as designed. To remind our readers, Diversified Leveraged Anchor was created in April 2020 attempting to further increase performance, reduce risk, and to reduce volatility. 

    By cwelsh,

    • 5 comments
    • 2,815 views
  • Should I Pay Off My Mortgage Early Or Invest?

    Paying off a home mortgage early is a popular financial goal. Most people feel a level financial peace when their home is paid off that is beneficial in many ways. The most common approach to paying off the mortgage early is directly making additional principal payments to the lender on a regular basis.

    By Jesse,

    • 0 comments
    • 1,339 views
  • Option Order Execution Tips

    As a community of option traders, we all can relate to the occasional challenges of order execution. Best practices for avoiding errors as well as techniques for better potential execution will be the focus of this article.  Like countless others in the Steady Options community, I personally have traded thousands of option contracts over the last decade.

    By Jesse,

    • 17 comments
    • 2,961 views

  Report Article

We want to hear from you!


Kim, great explanation about the Greeks. Was reading about Greeks on Investopedia after you discussed the recent impact from Theta outpacing Vega with regard to the FDX trade. Unfortunately Theta won, but now from this article, at least I better understand the relationships. Thanks.

Share this comment


Link to comment
Share on other sites

Good article,

"One possible strategy is to combine vega negative and theta positive trades with vega positive and theta negative ones."

Can you go into that more?

Share this comment


Link to comment
Share on other sites

My $0.02 is for those who are mathematically inclined, you can get a pretty good explanation of the greeks as components in the Black-Scholes model in Hull's or Sinclair's "Volatility Trading". Although I've forgotten the line-by-line derivation of BSM, the derivation helped me understand intuitively what each greek represent. 

Share this comment


Link to comment
Share on other sites

Good article, "One possible strategy is to combine vega negative and theta positive trades with vega positive and theta negative ones." Can you go into that more?

Example of vega negative and theta positive trade is butterfly. Example of vega positive and theta negative trade is straddle. So combining them will give a nice diversification. If the markets don't move, the fly will profit. If they do, straddle will produce nice gains. Together they balance each other.

Share this comment


Link to comment
Share on other sites

Kim, great explanation. After being a member for more than a year now, I finally start to understand what do you mean by "running a balanced portfolio with Greeks hedging each other". Having couple gamma positive trades when the markets make a big move can make a huge difference.

Share this comment


Link to comment
Share on other sites

Absolutely. 

I don't believe that you can succeed in the long term by trading just bunch of credit spreads or iron condors. You really need to understand how to use mix of strategies that hedge and balance each other.

Share this comment


Link to comment
Share on other sites

I agree that Greeks are very important. I ignored them when I just started trading, but over time you start to understand how to use them. I believe that gamma is especially important. It becomes critical as we get closer to expiration.

Share this comment


Link to comment
Share on other sites

I watched these video's when I joined, after getting a few SO style trades under my belt, I watched them again and they were that much more meaningful; to anyone joining the service, make sure you view these and if you dont get it, let it rest, follow some (paper) trades, come back to it again.

Share this comment


Link to comment
Share on other sites


Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido