Option Greeks for Traders : Part I, Delta, Vega & Theta: Extrinsiq Advanced Options Trading Guides, #5

OPTION GREEKS

FOR

TRADERS

Part I : Delta, Vega & Theta

Simon Gleadall

1st Edition

Extrinsiq Advanced Options Trading Guides

© 2021 Extrinsiq. All rights reserved.

First published by Volcube, 2014. This edition first published by Extrinsiq, 2021.

Disclaimer

This book does not constitute an offer or solicitation for brokerage services, investment advisory services, or other products or services in any jurisdiction.

The book’s content, tools and calculations are being provided to you for educational purposes only. No information presented constitutes a recommendation by the author or Extrinsiq to buy, sell or hold any security, financial product or instrument discussed therein or to engage in any specific investment strategy. The content, tools and calculations neither are, nor should be construed as, an offer, or a solicitation of an offer, to buy, sell, or hold any securities by the author or Extrinsiq. Neither the author nor Extrinsiq offer or provide any opinion regarding the nature, potential, value, suitability or profitability of any particular investment or investment strategy, and you are fully responsible for any investment decisions you make. Such decisions should be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance and liquidity needs.

Options involve risk and are not suitable for all investors. Options transactions are complex and carry a high degree of risk. They are intended for sophisticated investors and are not suitable for everyone.

Table of Contents

Disclaimer

About Extrinsiq

About the author

About the Extrinsiq Advanced Options Trading Guides series

Introduction

Calculating the Greeks

Running the position with factors altered

Which Greeks are covered in this volume

Delta

Basic definitions

Intuitive interpretations of delta

Market terminology

Determinants of delta

Hedging delta risk

Practical uses of delta

Exercises

Vega

Basic definition and notes

Market terminology

Determinants of vega

Hedging vega risk

Static and dynamic hedging plus the cost of hedging

Cross-expiry and cross-product vega hedges

Using vega when comparing option values

Exercises

Theta

Basic definitions and notes

Market terminology

The determinants of theta

Spot price relative to the strike price

Theta and Implied volatility

Theta and the time remaining until expiry

Hedging theta

Theta as the price of gamma

Exercises

Appendix

Solutions to exercises

Exercise 1

Exercise 2

Exercise 3

About Extrinsiq

Extrinsiq publishes educational material in the field of finance.

About the author

Simon Gleadall is an experienced professional options, futures, equity and fixed income ETF trader, as well as a best-selling finance author. He co-created Volcube, the world’s leading options training technology. He is based in London, England.

About the Extrinsiq Advanced Options Trading Guides series

Clear and concise guides that explore more advanced options trading topics. Check out the other volumes in the series...

Volume I :  Option Gamma Trading

Volume II :  Option Volatility Trading : Strategies and Risk

Volume III :  Option Market Making : Part I : An Introduction

Volume IV :  Trading Implied Volatility : An Introduction

Volume V : Option Greeks for Traders : Part I : Delta, Vega and Theta

Volume VI : Losing Money With Options : Advanced Techniques

Introduction

The Greeks are fundamental to understanding how options behave; how their values, and risk profiles, change. Managing an options portfolio means managing the Greeks. Many of the trading opportunities embedded in options are channelled via the Greeks. Hedging option risk efficiently often means hedging particular Greeks or groups of Greeks. In short, option trading success is all but impossible without a rigorous understanding of the Greeks.

This volume of the Extrinsiq Advanced Options Trading Guides series aims to explain the option Greeks as intuitively as possible. Whilst basic definitions may make some reference to mathematical formulae, this will be kept to a minimum. Rather, the focus is on the practicalities of the Greeks. How does the market talk about the Greeks? How do traders actually interpret and then act on their portfolio’s Greeks? To this end, examples will be in plentiful supply.

What are the Greeks? We can offer a fairly abstract definition: the Greeks are quantified estimates of changes to either option value or to other Greeks, with respect to a change in some other factor. Let’s strip that definition down into something more tangible. We start with an option. Let’s assume that this option has some value. This implies it has an amount of time left until expiration, its underlying product has a price presumably not a million miles away from the strike price and the spot product has some level of expected volatility in the future; in other words, a completely ordinary scenario for options that trade on thousands of products. Now, it is a safe assumption that the value of this option will change. It could change for many different reasons; perhaps the spot price moves or time passes or the expected volatility level falls. Or some other relevant factor may change; perhaps interest rates alter or the expected dividend on a stock changes. Things happen, the world turns and the option’s value is affected. For a trader, it would be nice to know in advance what these changes are going to be. But more likely than not, the trader has very little idea about what will happen. The next best thing to knowing what will happen, is to know how particular changes will impact on the option’s value. For instance, the owner of a call option knows that, in general, if the spot product rallies, his call becomes more valuable, but if the spot drops, the call loses value. He may not know which way the spot will move tomorrow, but it would be helpful to know exactly how big an impact changes in the spot are going to have on