Options Trading: A Guide To The Greeks

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As an options trading beginner, there’s a lot you have to learn. The minute you figure out how calls and puts work, you’ll have to focus on… well, the other stuff.

There’s a whole system of calculations on how options are priced. The system is connected to the internal and external factors that impact the underlying asset and the option value.

That being said, this article will breach you how to understand the options Greeks.

You’ll forget about Diogenes, Zeus, Apollo, and Poseidon. Instead, you’ll learn about delta, gamma, theta, vega, and rho, their importance in options trading, and how they are calculated.

What Are the Greeks Used in Options Trading?

The “Greeks” in options trading are, in fact, letters from the Greek alphabet used to describe a set of calculations related to the value of options contracts.

Each letter refers to a specific measure that helps the investor determine the risks of the option by focusing on the factors that impact the option value.

That’s a lot to say in one sentence, which is why we have the entire article to discuss the topic further.

We’ll take a look at each Greek separately. Before we start, remember this reference table because the Greeks know it to be confusing.

The Greeks in Options Trading

Delta

Many traders consider delta the most important risk factor out of all options trading Greeks. That’s because the price of the underlying asset directly influences it.

 Now, let’s see how delta is related to the underlying.

As one of the risk manager measures, delta calculates the price an option can reach if the underlying asset price changes.

For instance, a delta of 1 means that the option will move for $1 (theoretically) for every $1 change of the underlying.

Delta calculations

Delta in options is a decimal number ranging from -1 to 1. If we have a call option, the delta will be presented with a number from 0 to 1. With puts, it’s the other way around with the delta presented with a number from -1 to 0.

Now, there are many factors that determine delta. For instance, OTM and ITM options move differently.

On the other hand, ATM options have 0.50 (calls) or -0.50 (puts) deltas because there’s a 50/50 chance the option will go to ITM or OTM.

Also, the delta is affected by time too. For example when an ITM call option approaches the expiration date, the delta will go up and approach 1. On the other hand, as an ITM put option approaches the expiration date, the delta goes down and approaches -1.

Gamma

Out of all options trading Greeks, the gamma is the only one not related to the underlying asset, at least not directly.

Gamma measures the changes in the delta caused by changes in the underlying asset. As we said above, the delta goes up and down when the underlying changes and as the expiration date approaches. Therefore, the gamma captures the rate of those changes.

Traders use gamma to determine how stable the delta is. Since it focuses on the changes, gamma is a valuable tool.

For instance, if we have two options with the same deltas but different gamma values, the option with the lower gamma is more stable. It means that the option hasn’t experienced volatile swings.

Gamma calculations

It’s important to remember that gamma is a measure of delta changes. Remember that a higher gamma means a higher rate of delta changes. Hence, volatile swings and instability of the probability of being ITM at the expiration date.

Although there are mathematical equations regarding options gamma, the calculations you have to remember is that gamma has the lowest value when the option is deep OTM or ITM. So, for ATM options, the gamma value will be the highest.

Theta

This Greek may be the most important one. Some traders consider that delta has the No.1 position in importance because it’s related to the asset's current price.

However, time is unchangeable. It moves in one direction, and it affects everything.

Theta in options measures the rate of the time decay. It is the change (decrease) of the option’s price caused by time. In simple words, the time decay grows as the contract approaches the expiration date.

Theta is very important because it shows how much the option’s price is sensitive to the time. This measure moves only in one direction and is negative.

Theta calculations

There’s nothing complex when it comes to calculating theta. As we said above, theta is always negative for long options and increases as time passes. That’s because the expiration date approaches, and the holder doesn’t have much time to profit from the option.

Of course, theta is not moving the same for all options. First, it moves with an accelerated rate up to the end date, meaning the option's value marks a lower decrease at the beginning of the contract and a higher decrease at the end.

Also, the Greek depends on whether the option is OTM, ATM, or ITM. E.g., an ATM option and an OTM or ITM option on the same underlying have a different theta.

For the ATM option, the theta will be higher than for the other options because it has the most time value in the premium.

Vega

Along with the time decay, we have implied volatility. Vega focuses on the price changes caused by one-point shifts in implied volatility. Of course, this is all theoretical, as it is with the other Greeks.

To understand this risk factor better, you should make a comparison. As we said above, delta measures the rate of change in the price for every dollar change in the underlying.

On the other hand, Vega is focused on the future. It shows how much the option price will change (up or down) based on the changes in implied volatility.

Vega calculations

Vega is positive for long options and negative for short options. It’s also crucial to remember that vega can move up or down even when the underlying price stays still.

Some beginners are confused when it comes to interpreting vega values. That’s mainly because some people confuse volatility and vega.

If you have difficulties separating these two, think of them this way - volatility measures the fluctuations of the underlying; vega measures the sensitivity of the option to the changes in volatility.

Additionally, you should know that vega value falls as the contract approaches its expiration.

Rho

Delta, gamma, theta, and vega are the most important options trading Greeks in options trading. Most investors pay more attention to them than other risk factors, including rho.

However, rho can be very helpful, and it’s used to measure the change in the options price caused by a 1% change in the interest rates.

Some investors don’t pay much attention to rho because this Greek is not a big factor in the options price. However, you should consider rho if the market expects overall changes in the interest rates.

Rho values are positive for the calls and negative for the put options. That’s because the call value is higher when interest rates go up. Conversely, increased interest rates mean that the put option value will drop.

Other Greeks

Honestly, rho belongs to this group, because it simply exists, but main Greeks used in options trading are delta, theta, gamma, and vega.

However, you should know that multiple other risk factors can be considered when trading options. They’re not often used and can be confusing, especially for an options trading beginner.

The “minor” Greeks used in options trading are ultima, lambda, zomma, vomma, epsilon, vera, and speed. These are the second and even third derivatives of the price and can be connected to the main Greeks.

For instance, just like gamma is a second-order measure of an option’s delta, zomma measures the changes in the gamma. Frankly, it can be quite complicated, as zomma depends on a Greek that measures the rate of changes related to another Greek.

What Greeks to Look for When Buying Calls?

All Greeks can be helpful regardless of whether you’re buying call or put options. Delta changes with the underlying asset's price; gamma changes with delta. Theta shows you the expected drops caused by the time decay. Vega informs you of the potential changes caused by the implied volatility.

These options trading Greeks can be very helpful and direct you to make profitable trading decisions. Still, the fact remains that they are complex, and it’s a big challenge even to understand them, let alone use them to your advantage.

Keeping up with the market is a very time-consuming task, add the greeks on top of that, and it gets very complicated. Many traders and investors decide to look for a service like ours, Foolproof. We have a team of analysts looking at the market 24/7, we tell you when to, and what to buy. You can try us for 14 days, completely free.