For those of you trading options, option greeks must be familiar. Option greeks are mathematical calculations generated as output of the pricing model along with theoretical option price for the inputs provided to the model. These greeks give us insight into how an option will be affected by stock price, interest movements, time, and volatility( these are the inputs provided to the pricing model).
In this post, I will briefly cover what are first-tier and second-tier option greeks and in the later posts will cover in detail each option greek and how they are affected by the factors considered above.
Delta tells us how much an options price will change with the change in the price of the underlying stock
Gamma is called delta of delta. It will tell us how much the option's delta will change for every $1 movement in the price of the stock.
Theta stands for time decay and tells us the rate at which option price will decay on a timely basis.
Vega is a measure of options volatility sensitivity. it tells us how much the option price will change for one tick of volatility.
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The greeks mentioned above are major outputs of the pricing model and are called first-tier greeks. Below are mentioned second-tier greeks which measure the sensitivity of first-tier greeks to outside factors. They are usually represented by a number that can indicate the relationship between the first greek and the factor considered. For example, a V-delta of 400 represents your position delta and is indicating that for one tick of volatility, there will be 400 position delta ( total number of deltas in a portfolio. Will cover details in the upcoming delta post) change in the portfolio.
V-delta. measures the effect of change in volatility on delta.
T-delta. measures the effect of time on delta. In other words, it provides theta-delta relationship. It tells you how your delta position will change with time.
V-gamma measures the effect of volatility on gamma. This could be useful if you are gamma trading. We will discuss this in the later posts.
T-gamma measures the effect of the passage of time on gamma.
v-theta measures the effect of volatility on theta.
Final Thoughts
Are these greeks critical? Yes, they are. Options provide leverage and can be very profitable only if you understand risks. How do we understand risks? By understanding how the option price changes based on the stock price, interest rates, time and, volatility. These greeks help you understand what is going to happen or what can happen to positions before it can happen and gives traders the ability to hedge their portfolio, or construct positions with specific risk/reward profiles.
I learned options from Ron Lanieri, an options guru, through his education courses available at Market Rebellion and book "Option Theory and Trading" available at Amazon. He is no longer alive but continues to inspire option traders through his teachings. Most of the content presented here is referenced from his books and courses.
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