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Option greeks were the biggest pain in my butt when I first discovered options trading.
Learning how to trade stock options is hard enough and when people start throwing out terms like Delta, Gamma, Theta, Vega, and Rho in your face, it gets even harder.
For options trading novices, a clear understanding of how option greeks work can be very elusive.
I'll attempt to simplify the concepts so you can at least gain a basic understanding.
Despite what others may say, you can still make money trading stock options even if you don't fully understand the greeks. I know I did.
As you become more seasoned, you can gain a deeper understanding if you so choose to.
Greeks are parameters in the formula used to create option premiums (the price/cost of the stock option).
Delta, Gamma, Theta, Vega, and Rho are the five terms that make up the greeks. All five terms are associated with a stock options price or premium. It's the 5 "what if" scenarios so to speak.
For example: What if the stock goes up in value by $3, how much will the price of my stock option change? (Delta)
Before I proceed further, let me define the concepts for you. Don't worry about being a pro in the greeks. Just read for a basic understanding.
Option Delta is a measurement of how much an options price will change if the underlying stock moves up or down $1.00.
For example: A Delta of 50 (call option) means that the stock option price will increase/decrease by $0.50 for every $1 move in the stock's price either up/down.
So if I bought a stock option for $2.50 and the underlying stock increases in price by $1 then my stock option would rise in value to $3.00.
Option Gamma measures how much the Delta will increase/decrease for every dollar the stock moves. For instance, Gamma is 1.2 and Delta is 50, this means that if the stock moves up in value by $1 Delta will increase from 50 to 51.2.
Option Theta lets you know how fast your stock option will lose value as the days go by (it approaches expiration). A Theta of .05 means that the time value component of the option loses $0.05 every day that passes. The rate of price decay speeds up as the option approaches expiration.
Option Vega lets you know how much the stock option price will change as the volatility of the underlying stock changes.
Option Rho is an estimate of how much the stock option price will change when interest rates change. Rho is not used as often as the other 4, as interest rates don't change very often.
So essentially, the greeks measure how 4 different factors (change in stock price, interest rate, volatility, time) will affect the price of your stock option.
Hearing and trying to understand terms like Delta, Gamma, Theta, Vega, and Rho can be confusing and often leave you with the impression that options trading is just too hard to learn.
I hope I have helped to alleviate some of that frustration. Also watch the video below for more details...
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