Option Greeks are financial measures of sensitivity of the option's price to its underlying asset. The Greeks are used in the analysis of options portfolios and sensitivity analysis of a portfolio of options. The measures are known to be essential to many investors for making informed decisions in options trading.
Objective of Options Greek
Options contracts are utilized for hedging a portfolio. The motive is to offset potential unfavourable moves in other investments. Options contracts are known to be used for speculating on whether the asset's price could rise or fall. A call option, in brief, gives the holder of the option the right to purchase the underlying asset, while the put option lets the holder sell the underlying asset.
Option Greeks Explained
Options could be practised and converted to shares of the underlying asset at a particular price called the strike price. Each option has an end date that is called an expiration date and a cost of value that is associated with it called the premium. The premium of an option is typically based on an option pricing model that leads to fluctuations in price. They are usually viewed in conjunction with an option price model to assist in understanding and gauging associated risks.
There are several key options for Greeks, and they are - Delta, Gamma, Vega, Theta, and Rho. There are still a lot of Greeks that could be derived.
Types of Option Greeks
Mentioned below are the different types of options for Greeks.
Option Greek Delta
It's a measure of the sensitivity of an option's price changes that are relative to the changes in the underlying asset' prices. If the price of this underlying asset increases, the price of the option would change by an amount. Delta is found by ∂V/AS, where:
∂ = the first derivative
S = the underlying asset's price
V = the option's price
It is usually calculated as a decimal number from -1 to 1. Call options could have a delta from 0 to 1, and it puts a delta from -1 to 0. The closer the option to 1 t -1, the deeper the money option.
The Delta of the option's portfolio is the weighted average of the deltas of all options. It is known as a hedge ratio. If a trader knows the Delta of the option, he or she could hedge his or her position by buying or shorting the number of underlying assets that are multiplied by Delta.
Gamma Options Greek
Gamma is a measure of the Delta's change relative to the changes in the price of the underlying asset. If the price of the asset increases, the options delta would also change in the Gamma amount. The major application of Gamma is the assessment of the option's Delta. Long options have positive Gamma. An option has a maximum gamma when it is at the money. However, the Gamma decreases when an option is deep-in-the-money or out-the-money.
Option Greek Vega
Vega is an option Greek that would measure the sensitivity of the option price that is relative to the volatility of the asset. If the volatility of the assets increases by a per cent, the option price will change by the Vega amount. Vega is expressed as money amount over the decimal number. An increase in vega generally corresponds to an increase in the option value.
Theta Option Greeks
Theta is the measure of the sensitivity of the option price relative to the option's time to maturity. If the option's time to maturity goes down in one day, the option's price will change by the theta amount. The theta option in Greek is also referred to as time decay. Mostly, theta is negative for options. It shows the most negative value when the option is at the money.
Rho Option Greeks
Rho measures the sensitivity of that option price relative to increased rates. If a benchmark interest rate increased by a per cent, the option price would change by the RHO amount. The RHO is known to be the least significant among other option Greeks because the option prices are generally less sensitive to interest rate changes than to changes in other parameters. As usual, call options have a positive RHO, while the RHO for the put option is negative.
Some of the minor greeks that have not been discussed are lambda, epsilon, vomma, vera, speed, zomma, color, and time.
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