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I have recently picked up a few derivatives books for leisurely reading and have started to look into the option greeks. There are many e.g. delta, vega, theta, and gamma. There are others which are more obscure (at least to me) e.g. charm and speed.

Is it necessary to know these more obscure/higher order greeks? Or are there just a handful which carry most of the weight when trying to predict where an option price is likely to go? If so what are they?

Cheers -

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    Note that greeks don't tell you where an option price is likely to go as they work in both directions (mostly linearly for small movements). They tell you the sensitivity to external inputs. – D Stanley Nov 7 '19 at 13:12
  • Interesting point @D Stanley. However, isn't it true that the greeks give you the sensitivity of an option's value to a given input e.g. the underlying (delta). Hence, if I know where the underlying will go (e.g. +15% within a year), then surely I can figure out a (very) rough idea where the option price will be knowing the delta of that option? Is this then not the same as figuring out where the option price will be? – Choco93 Nov 8 '19 at 8:59
  • Yes if you have a specific position on the underlying price then you can use the sensitivities to calculate the estimated change in option price. But then again, you could also just use a pricing model to price the option with both sets of inputs and compare the results. You don't need the greeks for that. – D Stanley Nov 8 '19 at 13:17
  • @D Stanley. I see what you mean, and it would probably be a lot quicker as well. This also assumes your pricing model is right though no? If the Black Scholes model is shown to be wrong in practice (Vol smile) what do I do? – Choco93 Nov 8 '19 at 13:30
  • Well, sure, but the greeks come from the same model, so if the prices are wrong, then the greeks are wrong, too. – D Stanley Nov 8 '19 at 13:31
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The common Greeks (delta, gamma, vega, and theta) provide an estimate of the sensitivity of an option's price to pricing variables and the associated risk. It's important to note that this is a prediction of option pricing rather than a prediction of what options will make you money.

The importance of the Greeks depends on the level of one's sophistication and the extent of one's option portfolio. Here's my perspective as applicable to what I do on the retail side:

Theta is the rate of change between the option price and time, or time decay. It's important to be aware of it and to understand its non linear behavior but AFAIC, not much more than that.

Gamma, a second derivative, is the rate of change between an option's delta and the underlying asset's price. I have no use for gamma.

Vega represents the the option's sensitivity to volatility and is useful when trading volatility. An example would be the large expected expansion in implied volatility going into an earnings earnings announcement and the large contraction immediately thereafter. It's important for modeling the pricing what ifs of the EA play. Otherwise, day to day, not a significant stat for me.

Delta represents the rate of change between the option's price and a $1 change in the underlying asset's price. This is the most useful Greek for me because when I have a position comprised of 5 to 10 different options, some moving in conjunction with each other and some in opposition, it's important for me to avoid straying too far from delta neutral. To that end, I sell premium on one side or the other to restore neutral.

The Average Joe who executes simple vanilla strategies like covered calls and cash secured puts with the intention of acquisition or sale at a specific price doesn't need to know much, if anything, about the Greeks. Someone at the other end of the spectrum with a large diversified option portfolio would definitely need the Greeks to manage the risk (the extreme would be an options market maker).

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  • your answer seems to suggest that the key to understanding option price moves is delta. Have I interpreted your answer incorrectly? What I am trying to understand is - or the purpose of the original question - is why certain option prices move more than others. This may be too broad a question for this forum, but my initial inkling was that the greeks were the answer. Having read a bit further around options it appears implied volatility of the option is extremely important to understand - is this fair? – Choco93 Nov 8 '19 at 9:12
  • The key to understanding option price moves is the 6 option pricing inputs with volatility and price being the primary movers. Delta is an estimate of how much an option's price will move in reaction to the change in these variables. If you want to know why certain option prices move more than others, examine an option pricing formula such as Black Scholes. If you just want to just observe the magnitude of price change then one by one, vary the values of the inputs one by one and see the effect of changing the value of each each on option price. – Bob Baerker Nov 8 '19 at 12:21
  • Yes, implied volatility is extremely important to understand. It's common to see noob questions on blogs that ask "Why did the stock move up (down) today but the value of my option didn't change?" Hint: It was because of IV. – Bob Baerker Nov 8 '19 at 12:22
  • Thanks @Bob Baerker I will have a look at modelling the BSM in Excel so I can get a feel for what it is doing. – Choco93 Nov 8 '19 at 13:02
  • Just a bit more on implied volatility: is the holy grail then to find a situation where the underlying is likely to move a lot (based on some analysis) but for whatever reason the market is not anticipating it and so the IVs on the options are very low? I have also read in certain places the IV of an option is used to "correct" for some of the BSM's limitations, is this true? Are there any resources showing how this is done? – Choco93 Nov 8 '19 at 13:04

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