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Anatomy of an Option: Greeks

For those who are trading options, there are a few other factors that affect an options price rather than just the underlying stock. If youre holding an option for stock XYZ on Monday and the stock is trading at $40, and then on Tuesday the stock is still trading at $40, you may notice your option drop in value and then you wonder why you lost some money. This is because options are affect by a variety of factors which we are represented on the charts using Greek symbols. Remember that the main difference between options and stocks are that options expire, thus time plays a major role in options trading.

There are four Greeks associated with each option: Delta. Gamma. Theta. and Vega. Below is a sample chart showing the Options chain for Apple, Inc with greeks:

Delta

For each point the underlying stock moves, its options equivalent will move a certain amount too. The delta of the option determines how much this move is. The delta is generally between 0 and 1 for each contract share of a call option or 0 and -1 for a put option. Since an option represents 100 contract shares, the above picture depicts deltas between 0 to 100 and 0 to -100 instead. For example, the Nov 12 655.0 Call Options have a delta of 59 so for each point that Apple moves up or down, the options contract value will move $59 up or down.

For Put options, the delta is negative because the dollar value of contract moves in the opposite direction of the stock. For example, taking the Nov 12 655.0 put options, for each point that Apple moves down, the option will move up $44 and vice versa.

Deltas are higher the deeper in-the-money you go and lower the more out-of-the-money you go.

Gamma

How do we determine how much the delta changes between In-the-money, out-of-the-money, and at-the-money option ranges? We use gamma.

Gamma measures the rate of change for a delta for each point moved during a specific time period. In the above example, we can note that all Oct 12 options have a gamma of 0.6 and the November options have a gamma of either 0.5 for 0.4. Gamma stays pretty constant. So for the Oct 12 options, for each 1 point move in Apple, the gamma will cause the delta to change by 0.6 per point moved. Thats why between the 5-point strike prices you see a 3-4 delta difference.

Theta

Theta is the measure of time decay in an option. When you buy and hold an option, theta is your enemy. Your option will decay over time the closer you get to expiration. If you write an option, theta becomes your friend. Writing an option off at $500 and watching it decay over time will generate you that much profit in return and if the option expires worthless, you earn the full $500.

The value of theta represents how much the option will decay per day. In the above chart, an Oct 12 660.0 call will have a depreciation rate of about $0.438 per contract share or $43.80 per option per day. This is assuming that the stock does not move. If the stock does move, the underlying move could case the contract to increase/decrease in value but by the end of the day, the theta would have already been calculated into the option value.

Vega

Vega represents how much an option price can be affected by volatility changes. If an option becomes more volatile all of a sudden, the value of the option could increase by an amount close to vega. For the Oct 12 660.0 option, a 1% change in volatility would move the option price by about 0.893 per contract share or $89.30 per option. The longer you buy the option, the higher the vega. This is because of uncertainty of news and events that could occur between the purchase date and the expiration date.