Option Greeks are the parameters used to measure an option's sensitivity to changes in the price of the underlying asset, market volatility, or time to expiration. They provide traders with a theoretical way to assess their exposure to these factors, which influence options pricing.
There are five primary Greeks:
Delta (δ)
Gamma (γ)
Vega (ν)
Theta (θ)
Rho (ρ)
Here's what each represents:
Delta (δ) – It measures the degree to which an option price will move given a change in the underlying asset price, assuming all other factors remain constant. Delta is expressed on a scale of 1 to -1. For example, an option with a delta of 0.50 will move 50 paise for every one-rupee movement in the underlying asset. Options with a higher delta will increase/decrease in value more with the same move in the underlying asset, whereas options with a lower delta will be less sensitive. A far out-of-the-money option will have a delta close to zero, an at-the-money option around 0.50, and a deep in-the-money option close to 1 or -1.
[Inserting a chart for Nifty Option where Nifty Spot is trading at 15810 and expiry is 30 days away would require a specific image or data to be included.]
(Note: Please provide the specific data or description for the Nifty Option chart if you want it to be included.)
From the table, you can observe that puts have a negative Delta value, as a put option will always exhibit an inverse relationship with the spot price of Nifty. For call options, the Delta fluctuates between 0 and 1, while for put options, it fluctuates between -1 and 0.
Gamma (γ) – Gamma of an option indicates how the Delta of an option will change concerning a 1-point move in the underlying asset. In simpler terms, Gamma reflects the sensitivity of the option Delta to changes in the market price. It is crucial because it illustrates how rapidly the Delta of our position alters with shifts in the market price of the underlying asset. However, it is not typically required for calculations in most option trading strategies. Gamma tends to be higher for at-the-money (ATM) options and lower for options that are in-and out-of-the-money.
(In the example below, Gamma values for the at-the-money strike of 15800 are high compared to strikes 15000 and 16500.)
Gamma is crucial for traders who employ Delta neutral strategies, as high Gamma can impact Delta and cause imbalances.
Vega (v) - The Vega of an option indicates how much the option's price will change concerning the underlying asset's volatility. For instance, an option with a Vega of 0.20 implies that the option's value is expected to change by 20 paise if the implied volatility changes by 1%. Vega is at its maximum for at-the-money options and decreases as we move away from the spot price.
(In the example below, you can observe that Vega is at its maximum for the at-the-money option with a strike price of 15800.)
Vega accounts for the risk that the option seller is exposed to based on the current and estimated volatility of the underlying asset. Increased volatility suggests that the underlying asset is more likely to undergo extreme price fluctuations.
Theta (θ) - Theta of an option indicates the rate of change between the option price concerning time. It is also known as an option's time decay. Theta reveals how much an option's price would decrease as the time to expiration approaches, all else being equal. For example, suppose a trader has bought a call option with a theta of -0.70. In that case, the option's price would decrease by 70 paisa every day that passes, with other factors remaining constant. Theta is high for at-the-money options and decreases when options are in- and out-of-the-money. Additionally, the rate of decay increases as the time to expiration approaches for that option.
(In the example below, the Nifty Spot value is around 15810 on June 29th for the options contract with the expiration date of July 29th.)
A negative theta indicates that the option will lose value due to time decay.
Theta is favorable for option sellers but unfavorable for buyers, as the value decreases for the buyer over time while increasing for the seller. The value of theta will be zero at the time of expiry.
Rho (ρ) - Rho measures the sensitivity of an option or options portfolio to a change in interest rates. For example, a call option with a rho of 0.10 and a price of Rs.1.50 would see its value increase to Rs.1.60 if interest rates rise by 1%, assuming all other factors remain constant. The opposite is true for put options. Rho is highest for at-the-money options and decreases further away. However, it's important to note that option prices do not change significantly with changes in the risk-free rate.
Important points to consider about Option Greeks:
- Greeks do not work in a vacuum. They are constantly changing, and a change in one can affect all the other Greeks.
- Greeks help you analyze your exposure to various options-centric risks related to the underlying asset movement, time, and volatility.
- Greeks can help you plan your trades to take advantage of or minimize the effects of these risks.
- Greeks can help you manage your trades by showing how the trade exposure has changed concerning these risks.