The Greeks: What You Should Know Part 2 A lot of us know ...
The Greeks: What You Should Know Part 2
A lot of us know what the Greeks do individually but aren’t as certain on how they behave in relation to each other and the underlying asset. This write up will be done with the assumption you have read the previous post here:
Quick Example
Say John buys XYZ 100 1/15/21 Call (Buy-to-Open) for 1.00 and this contract has the following values:
Delta: 0.50 Gamma: 0.05 Theta: -0.02 Vega: 0.01
and the Current price of XYZ stock is $95.00.
This tells a lot but we will start with how Delta and Gamma work together:
(1) The Delta says that for every $1 move either up or down in price, will either decrease or increase the value of the option contract by 0.50 (e.g. $50). You will notice most option contracts are bought and measured for statistical purposes in the ranges of 0-0.20, .21-.40, .41-.60, .61-80, and .81-1.00.
(2) Then because Gamma is 0.05, for every change in Delta relative to a $1 movement in the underlying asset, The value of the option contract will increase by an additional 0.05 ($5) for every additional $1dollar change in the underlying assets price which would there create a correlated change in delta which is measured by gamma. So if the option contract for XYZ is 1.00 when the price of the underlying asset is $95 and then price moves up $1 dollar then the value of the contract becomes 1.50. (1.00 + 0.50) THEN, if the price moves an additional $1, Then the equation becomes, (1.50 + 0.50 + 0.05) = 2.05.
We add Delta and Gamma together whenever we have additional 1$ movements or quantifiably similar changes in delta.
(3) Theta, which is the amount of daily time decay that decreases the value of your options contract. So here we know that even if delta and gamma increase, With Theta being -0.02 we can expect to lose 0.02 every day we hold this contract. INCLUDING WEEKENDS. So now the Equation becomes 2.05 (current value of delta + gamma after a $2 movement) – 0.02 = 2.03.
(4) Vega tells us that if Implied Volatility has a 1% change, then Vega will correlate the price increase or decrease related to the premium paid to buy/sell an option contract. If Vega is 0.01 then we add that to the value of the option contract. With 2.03 (Delta + Gamma – Theta) + 0.01 ($1) = 2.04.
We do not use RHO in this calculation.
Please note that these are not Static numbers and they will change drastically in relation to volume.
You will notice Greek Combinations that have very high Delta and Gamma and Vega translates to an option most likely having a Higher Implied volatility because of how much of a range the option can move in and out of the money from delta and gamma while understanding from Vega that there is also a lot of dynamic price movement to either side. You will find these combinations in ETF’s like SLV, GOLD, XLK, things like that. Because they have high In-the-money probabilities and because their price doesn’t move much, GAMMA is very high which in turn means that smaller changes in delta will add to your contract value quicker.
The most important thing here is understanding the formula and making sure there is liquidity (Volume and open interest) in your contract position.
I did want to touch on straddles and covered calls which many believe is a better way to trade options in terms of risk vs. reward.
Straddles
When an Investor is not sure which direction the market will move but has a strong opinion that there will be dynamic movement, a strategy that might be employed is the purchase of a straddle. This is the combining of a put and a call on the same stock with the same exercise price and expiration date. If the stock moves up, a profit is made on the call; if down, a profit is made on the put. Those who buy a straddle will profit from volatility while those who sell a straddle will profit if the market is stable because the options will expire unexercised.
Writing Calls
A Neutral or Bearish investor can write (sell) a call and collect the premium. An investor who believes a stock's price will stay the same or decline can write a call to:
(1) Generate income from the option premium
(2) partially protect (hedge) a long stock position by offsetting any loss on the sale of the stock by the premium amount
(3) If the stock price increases, the call may be exercised. In addition to the premium received when the option was sold, the writer will be paid the strike price for the stock.
If the option writer is the owns the stock on which the call is being written, is it known as a covered call and the risk is limited because no matter how high the stock price rises (meaning the call will certainly be exercised) , the writer merely uses the stock already owned (which has been deposited with the broker-dealer) to make delivery. However, if the writer does not own the stock, the option is uncovered (usually referred to as "naked" in the industry). That's when the risk is unlimited, because the writer must pay the going market price (and there is theoretically no limit as to how high a stock's price can go) to acquire the stock needed to fulfill the obligation to deliver. That is why Naked Call writing is the most risky option strategy.
There much more to learn
Hope this helps!
$Assertio Therapeutics $Novan $Genius Brands $Castor Maritime Inc $IBIO $MicroVision $Nikola Corporation $Workhorse Group $Jaguar Health $NIO Inc. $ $Ideanomics(IDEX.US$ $Jaguar Health(JAGX.US$ $Ocugen(OCGN.US$ $Assertio(ASRT.US$ $Novan Inc(NOVN.US$ $Castor Maritime(CTRM.US$ $Genius Brands International Inc(GNUS.US$ $ $Microvision(MVIS.US$ $Workhorse(WKHS.US$ $iBio Inc(IBIO.US$ $NIO Inc(NIO.US$ $Apple(AAPL.US$ $Alibaba(BABA.US$ $PDD Holdings(PDD.US$ $Bilibili(BILI.US$ $Futu Holdings Ltd(FUTU.US$ $Tesla(TSLA.US$
check out Our youtube channel called Togethearn!
A lot of us know what the Greeks do individually but aren’t as certain on how they behave in relation to each other and the underlying asset. This write up will be done with the assumption you have read the previous post here:
Quick Example
Say John buys XYZ 100 1/15/21 Call (Buy-to-Open) for 1.00 and this contract has the following values:
Delta: 0.50 Gamma: 0.05 Theta: -0.02 Vega: 0.01
and the Current price of XYZ stock is $95.00.
This tells a lot but we will start with how Delta and Gamma work together:
(1) The Delta says that for every $1 move either up or down in price, will either decrease or increase the value of the option contract by 0.50 (e.g. $50). You will notice most option contracts are bought and measured for statistical purposes in the ranges of 0-0.20, .21-.40, .41-.60, .61-80, and .81-1.00.
(2) Then because Gamma is 0.05, for every change in Delta relative to a $1 movement in the underlying asset, The value of the option contract will increase by an additional 0.05 ($5) for every additional $1dollar change in the underlying assets price which would there create a correlated change in delta which is measured by gamma. So if the option contract for XYZ is 1.00 when the price of the underlying asset is $95 and then price moves up $1 dollar then the value of the contract becomes 1.50. (1.00 + 0.50) THEN, if the price moves an additional $1, Then the equation becomes, (1.50 + 0.50 + 0.05) = 2.05.
We add Delta and Gamma together whenever we have additional 1$ movements or quantifiably similar changes in delta.
(3) Theta, which is the amount of daily time decay that decreases the value of your options contract. So here we know that even if delta and gamma increase, With Theta being -0.02 we can expect to lose 0.02 every day we hold this contract. INCLUDING WEEKENDS. So now the Equation becomes 2.05 (current value of delta + gamma after a $2 movement) – 0.02 = 2.03.
(4) Vega tells us that if Implied Volatility has a 1% change, then Vega will correlate the price increase or decrease related to the premium paid to buy/sell an option contract. If Vega is 0.01 then we add that to the value of the option contract. With 2.03 (Delta + Gamma – Theta) + 0.01 ($1) = 2.04.
We do not use RHO in this calculation.
Please note that these are not Static numbers and they will change drastically in relation to volume.
You will notice Greek Combinations that have very high Delta and Gamma and Vega translates to an option most likely having a Higher Implied volatility because of how much of a range the option can move in and out of the money from delta and gamma while understanding from Vega that there is also a lot of dynamic price movement to either side. You will find these combinations in ETF’s like SLV, GOLD, XLK, things like that. Because they have high In-the-money probabilities and because their price doesn’t move much, GAMMA is very high which in turn means that smaller changes in delta will add to your contract value quicker.
The most important thing here is understanding the formula and making sure there is liquidity (Volume and open interest) in your contract position.
I did want to touch on straddles and covered calls which many believe is a better way to trade options in terms of risk vs. reward.
Straddles
When an Investor is not sure which direction the market will move but has a strong opinion that there will be dynamic movement, a strategy that might be employed is the purchase of a straddle. This is the combining of a put and a call on the same stock with the same exercise price and expiration date. If the stock moves up, a profit is made on the call; if down, a profit is made on the put. Those who buy a straddle will profit from volatility while those who sell a straddle will profit if the market is stable because the options will expire unexercised.
Writing Calls
A Neutral or Bearish investor can write (sell) a call and collect the premium. An investor who believes a stock's price will stay the same or decline can write a call to:
(1) Generate income from the option premium
(2) partially protect (hedge) a long stock position by offsetting any loss on the sale of the stock by the premium amount
(3) If the stock price increases, the call may be exercised. In addition to the premium received when the option was sold, the writer will be paid the strike price for the stock.
If the option writer is the owns the stock on which the call is being written, is it known as a covered call and the risk is limited because no matter how high the stock price rises (meaning the call will certainly be exercised) , the writer merely uses the stock already owned (which has been deposited with the broker-dealer) to make delivery. However, if the writer does not own the stock, the option is uncovered (usually referred to as "naked" in the industry). That's when the risk is unlimited, because the writer must pay the going market price (and there is theoretically no limit as to how high a stock's price can go) to acquire the stock needed to fulfill the obligation to deliver. That is why Naked Call writing is the most risky option strategy.
There much more to learn
Hope this helps!
$Assertio Therapeutics $Novan $Genius Brands $Castor Maritime Inc $IBIO $MicroVision $Nikola Corporation $Workhorse Group $Jaguar Health $NIO Inc. $ $Ideanomics(IDEX.US$ $Jaguar Health(JAGX.US$ $Ocugen(OCGN.US$ $Assertio(ASRT.US$ $Novan Inc(NOVN.US$ $Castor Maritime(CTRM.US$ $Genius Brands International Inc(GNUS.US$ $ $Microvision(MVIS.US$ $Workhorse(WKHS.US$ $iBio Inc(IBIO.US$ $NIO Inc(NIO.US$ $Apple(AAPL.US$ $Alibaba(BABA.US$ $PDD Holdings(PDD.US$ $Bilibili(BILI.US$ $Futu Holdings Ltd(FUTU.US$ $Tesla(TSLA.US$
check out Our youtube channel called Togethearn!
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