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

  • Fear of Options Assignment

    One of the most common fears in option trading is one of early assignment.  The fear of having a large number of shares (or a large short position) coupled with a potential margin call (or Reg-T call) causing a sudden shortage of cash in their accounts worries investors.  Investors commonly view assignment as a huge potential risk.

    By cwelsh,

    • 0 comments
    • 76 views
  • The Value of Equity Asset Class Diversification

    This investing lesson is a tale of two time periods that highlight the important role of equity asset class diversification and systematic rebalancing in an equity fund portfolio.  Human nature is a failed investor, when our natural instinct is often to do the exact opposite of what we should do in practice.

    By Jesse,

    • 0 comments
    • 95 views
  • Lessons from Bill Ackman's comeback

    Bill Ackman is an American investor, hedge fund manager and philanthropist. He is the founder and CEO of Pershing Square Capital Management, a hedge fund management company. Ackman is considered by some to be a contrarian investor but considers himself an activist investor.

    By Kim,

    • 0 comments
    • 455 views
  • Exercise Risk of Uncovered Calls

    Exactly how risky are uncovered calls? That depends … Some traders avoid uncovered calls altogether because the risk can be significant, even unlimited (in theory). Others can rationalize this strategy as only moderately risky based on how you pick expiration and strike.

    By Michael C. Thomsett,

    • 0 comments
    • 162 views
  • Cash is (no longer) Trash

    According to www.bankrate.com, the current national average interest rate on bank savings accounts is only 0.10%. Many banks have barely budgeted on increasing interest rates even as the risk-free rate of return on a US Treasury Bill is currently in excess of 2%. This spread is a substantial profit margin for banks.

    By Jesse,

    • 0 comments
    • 260 views
  • The Danger of False Signals

    Everyone has heard about the troubling “false signals,” a price-based reversal indicator that shows up but does not lead to reversal. This is frustrating and expensive, but the problems in how traders react to false signals can be managed effectively with a few techniques.

    By Michael C. Thomsett,

    • 0 comments
    • 331 views
  • How Earnings Impact Options Prices

    Yesterday I closed our SE May 22.5 buy-write for a couple of reasons. First off, I knew that the position only had ~$0.20 more to gain over the next three weeks. I also knew those gains would take some time to capture as out-of-the-money puts (which is essentially what the May 22.5 buy-write is) hold their value until right before expiration.

    By Jacob Mintz,

    • 0 comments
    • 220 views
  • Options in the Media

    In general, financial reporting is a scam.  The daily highlights of “President Trump had eggs for breakfast causing futures traders to worry as markets decline slightly” or “Markets up on Mickey Mouse’s birthday,” always amaze me at the abject lack of correlation. 

    By cwelsh,

    • 0 comments
    • 276 views
  • Steady Momentum ETF Portfolio

    Last May, I wrote an article about how to analyze an investment strategy. Today I’ll use the concepts from that article to explain how the Steady Momentum ETF Portfolio (available as a bonus strategy to Steady Momentum subscribers) meets the criteria described in that article.

    By Jesse,

    • 0 comments
    • 409 views
  • Where to Find Exceptional Trading Data?

    Options traders are “data wonks,” meaning we all rely on information to make what we hope are informed decisions. But how do you know the difference between valuable and reliable data on the one hand, and rumor or speculation on the other?

    By Michael C. Thomsett,

    • 0 comments
    • 462 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


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