Option Greeks
by J Victor on February 18th, 2013Greeks.
In options, ‘Greeks’ means a group of Greek alphabets that are used to represent certain values related to volatility of Option premiums. There are 5 measures of volatility – Delta (Δ), Gamma (Γ), Vega (ν), Theta (θ) and Rho (ρ) which commonly used by investors. These are called option Greeks.
We already know that option contracts keep changing in values due to changes in one or more of the several variables such as – price of the stock, the risk free rate of interest, time to expiry, volatility etc . To explain the relationship between each of these variables and option premium, a Greek letter is used as a short form for example – Delta of an option (symbol Δ) explains the rate of change in the option price with respect to the underlying share price.
So Greeks basically measure the sensitivity of option prices to various factors affecting it.
5 Greeks.
Delta (Δ) – delta is the rate of change in option premium when there is a change in the price of the underlying asset, assuming that other factors remain unchanged.
Gamma (Γ) – Gamma is the rate of change in the delta for one when there is a change in the price of the underlying asset, assuming the other factors remain constant.
Vega (ν) – Vega is the rate of change in the option premium when compared to the volatility of the underlying share.
Theta (θ) – Theta is the rate of change in option premium when there is a change in the time to expiry.
Rho (ρ) – Rho is the rate of change in option premium when there is a change in the rate of risk free interest.
Why Greeks are important
The rate of change or the effect of change in option premium when each variable changes is a vital information for those who use options for the purpose of risk hedging. For example – if the Delta of an option is .50 it means that when the underlying price of the stock changes by Re 1, the option price changes by 50%. This information can be used effectively in various scenarios. For example, an in –the –money option with higher delta would be give more profits when compared to an inthemoney option that has a lower delta.
How are they computed?
All option Greeks are computed using the black scholes formula. Deriving option Greeks may not be a feasible idea unless you are academically interested in doing math. It is not important to learn how Greeks are computed at the same time, it is very important to know the application of these measures. As we said in our last post on blackscholes model, option calculators are available online from various sources. Given below is the option calculator link from the BSE. Those who want to value options can use this calculator.
Click here for options calculator.
In our subsequent posts, we will go into detail on all the option Greeks so as to understand it closely.
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