GREEKS- a Primer- Why you should care?
Appreciate if you could rate the thread- as I would assume it is in essence a thank you note and more importantly that whoever visits can follow the discussion without searching for threads to read. It is a good habit- rate the thread!
There are some Co-efficents that result from the B-S module. No point discussing advance mathematics- let us get to what matters practically. I will restrict this to discussion on Delta- which perhaps will be not only easier to comprehend- but will help understand your positions
For your Info these are the brief definitions of Greeks- like Panch Pandav- if you want an Indian Context/ Of these theta and rho are usually not that important ( theta- become important if you are talking of a longer time frame)
delta - a measure of an options sensitivity to changes in the price of the underlying asset
gamma - a measure of deltas sensitivity to changes in the price of the underlying asset
Vega - a measure of an options sensitivity to changes in the volatility of the underlying asset
theta - a measure of an options sensitivity to time decay
rho - a measure of an options sensitivity to changes in the risk free interest rate
I have seen several posts that talking about buying or selling calls and puts- but without much understanding/ or background info. These 5 Parameters- basically will define your exposure to risk depending on various factors. If you understand these well- then you can basically convert your position mathematically- and gain more insight as to what will happen to your trade if you vary different things- say range of movement of the underlying etc.
Let us go back to Physics 101- very basic stuff. We all hear of velocity and we all heard of acceleration- In the case of options- think of Delta as Velocity and Vega as the Acceleration ( for more mathematically inclined people this is first and second partial derivatives- but let us not worry about that!)
Why is Delta Important?
The most important reason is that you get to do what if scenarios on what happens to your position if the underlying stock moves by say 1 rupee! The thumb rule is that ATM ( At The money) Options will have typically a delta of 0.5- , Far out of the money OTM options are close to zero, and ITM ( deep in the money) are close to 1.
In reality- the ATM will be about 0.55 to 0.6 and Even Deep ITM will have something closer to 0.9. ( For PUTs which mirror calls Delta will be negative)
As the underling Asset ( Say a stock or index) moves either way- the option price moves ( all other things being constant)- if you want to know by how much, then Delta will tell you that info.
For example if you bought ATM Calls for a stock the delta ( let us assume) is 0.5. If the Stock goes up by 20 rupees- the option should go up by 20 multiplied by 0.5 10 rupees ( assuming you bought 1 call option). Please notice I subtly mentioned ( All things being equal!). You do need to understand that as the underlying stock moves the Cousin of Delta- Vega works to add more Delta to your position assuming the price is going up. So basically your position will be generating more deltas than what was there originally- and making it more and more bullish. This is very important to understand- Delta is NOT static! ( Vega is like the turbo charger for Delta!)
If on the other hand you sell calls the deltas will be negative ( and it will be bearish). A equivalent argument holds for Puts- i.e. if you buy puts- you will have negative deltas- and vice versa.
So when you deal with options please make sure you know the position delta of your trade. What is position Delta? Simply put you use a delta of 1 if you buy a stock- so if you buy 100 shares your position Delta is 1 Multiplied by 100 shares= 100 Deltas. A stock does not have Vega- that is important to remember- so delta stays at 1.
For option position- if you say buy a ATM option- delta will be about 0.5 so if you have 100 options- your position Delta will be 0.5 Multiplied by 100 i.e. 50 Deltas- Now notice the difference in deltas- for the case of buying 100 shares versus the 100 ATM options?
Which one has more Deltas? That is why it is important to know what your delta for the Option positions- to understand how bullish your position is. So in the above case- if you want to have an option position exactly similar to 100 shares ( purchase) you will have to buy ) 0.5 * 200 equals 100 Deltas- so you have to buy 200 options to simulate the same !
So why bother with options? The reason is simple- you will be paying a fraction of the price for the 200 options! So if your reasoning for a buying a stock is that let us say it will go up 20 rupees in a week- my suggestion is you will have a better risk to reward bought equivalent Deltas using options- because your investment will be fraction ( and hence you are limiting the risk). Of course time frames etc is an important issue- with stocks if it goes down in the time frame you have- you just have a paper loss, if you are dealing with options- before expiry if your guess was not correct- then you are losing your premium! So do understand these things- and dont blame options for burning you- it is like fire, you can do a lot of good things, but you can also destroy it if you use it callously. Remember the bonus with options is if the trade starts out bullish and gets more bullish ( i.e. stock moves more in the positive direction than you anticipated) your original delta position will keep increasing- because of our dear cousin Vega who is doing his job!
This in essence is the importance of delta- I will discuss Delta neutral trading in another thread.
If you know all the 5 Greeks- of your option position basically you know a lot about your position- and can either enhance or take effective counter measures. That is why your Options ( Dream Car)- should have these 5 Dials in technicolor- in addition to IV/HV measure- Just look at how much information is hidden when you just consider the option price to make trades!
If anything- next time you do a trade- please do check your position and understand it in terms of Greeks and the IV /HV context
One very important thing to remember is the please remember this regarding Vega- it is a 1% change in volatility not ie if Volatility is 50- the change should be 5% to get a change in price. The others are all based on absolute numbers not percentages.
Hope this was helpful. I have tried to be as factual- but I am human so please do correct errors that may have crept in- after all I am just a volunteer.
Appreciate if you could rate the thread- as I would assume it is in essence a thank you note and more importantly that whoever visits can follow the discussion without searching for threads to read. It is a good habit- rate the thread!
There are some Co-efficents that result from the B-S module. No point discussing advance mathematics- let us get to what matters practically. I will restrict this to discussion on Delta- which perhaps will be not only easier to comprehend- but will help understand your positions
For your Info these are the brief definitions of Greeks- like Panch Pandav- if you want an Indian Context/ Of these theta and rho are usually not that important ( theta- become important if you are talking of a longer time frame)
delta - a measure of an options sensitivity to changes in the price of the underlying asset
gamma - a measure of deltas sensitivity to changes in the price of the underlying asset
Vega - a measure of an options sensitivity to changes in the volatility of the underlying asset
theta - a measure of an options sensitivity to time decay
rho - a measure of an options sensitivity to changes in the risk free interest rate
I have seen several posts that talking about buying or selling calls and puts- but without much understanding/ or background info. These 5 Parameters- basically will define your exposure to risk depending on various factors. If you understand these well- then you can basically convert your position mathematically- and gain more insight as to what will happen to your trade if you vary different things- say range of movement of the underlying etc.
Let us go back to Physics 101- very basic stuff. We all hear of velocity and we all heard of acceleration- In the case of options- think of Delta as Velocity and Vega as the Acceleration ( for more mathematically inclined people this is first and second partial derivatives- but let us not worry about that!)
Why is Delta Important?
The most important reason is that you get to do what if scenarios on what happens to your position if the underlying stock moves by say 1 rupee! The thumb rule is that ATM ( At The money) Options will have typically a delta of 0.5- , Far out of the money OTM options are close to zero, and ITM ( deep in the money) are close to 1.
In reality- the ATM will be about 0.55 to 0.6 and Even Deep ITM will have something closer to 0.9. ( For PUTs which mirror calls Delta will be negative)
As the underling Asset ( Say a stock or index) moves either way- the option price moves ( all other things being constant)- if you want to know by how much, then Delta will tell you that info.
For example if you bought ATM Calls for a stock the delta ( let us assume) is 0.5. If the Stock goes up by 20 rupees- the option should go up by 20 multiplied by 0.5 10 rupees ( assuming you bought 1 call option). Please notice I subtly mentioned ( All things being equal!). You do need to understand that as the underlying stock moves the Cousin of Delta- Vega works to add more Delta to your position assuming the price is going up. So basically your position will be generating more deltas than what was there originally- and making it more and more bullish. This is very important to understand- Delta is NOT static! ( Vega is like the turbo charger for Delta!)
If on the other hand you sell calls the deltas will be negative ( and it will be bearish). A equivalent argument holds for Puts- i.e. if you buy puts- you will have negative deltas- and vice versa.
So when you deal with options please make sure you know the position delta of your trade. What is position Delta? Simply put you use a delta of 1 if you buy a stock- so if you buy 100 shares your position Delta is 1 Multiplied by 100 shares= 100 Deltas. A stock does not have Vega- that is important to remember- so delta stays at 1.
For option position- if you say buy a ATM option- delta will be about 0.5 so if you have 100 options- your position Delta will be 0.5 Multiplied by 100 i.e. 50 Deltas- Now notice the difference in deltas- for the case of buying 100 shares versus the 100 ATM options?
Which one has more Deltas? That is why it is important to know what your delta for the Option positions- to understand how bullish your position is. So in the above case- if you want to have an option position exactly similar to 100 shares ( purchase) you will have to buy ) 0.5 * 200 equals 100 Deltas- so you have to buy 200 options to simulate the same !
So why bother with options? The reason is simple- you will be paying a fraction of the price for the 200 options! So if your reasoning for a buying a stock is that let us say it will go up 20 rupees in a week- my suggestion is you will have a better risk to reward bought equivalent Deltas using options- because your investment will be fraction ( and hence you are limiting the risk). Of course time frames etc is an important issue- with stocks if it goes down in the time frame you have- you just have a paper loss, if you are dealing with options- before expiry if your guess was not correct- then you are losing your premium! So do understand these things- and dont blame options for burning you- it is like fire, you can do a lot of good things, but you can also destroy it if you use it callously. Remember the bonus with options is if the trade starts out bullish and gets more bullish ( i.e. stock moves more in the positive direction than you anticipated) your original delta position will keep increasing- because of our dear cousin Vega who is doing his job!
This in essence is the importance of delta- I will discuss Delta neutral trading in another thread.
If you know all the 5 Greeks- of your option position basically you know a lot about your position- and can either enhance or take effective counter measures. That is why your Options ( Dream Car)- should have these 5 Dials in technicolor- in addition to IV/HV measure- Just look at how much information is hidden when you just consider the option price to make trades!
If anything- next time you do a trade- please do check your position and understand it in terms of Greeks and the IV /HV context
One very important thing to remember is the please remember this regarding Vega- it is a 1% change in volatility not ie if Volatility is 50- the change should be 5% to get a change in price. The others are all based on absolute numbers not percentages.
Hope this was helpful. I have tried to be as factual- but I am human so please do correct errors that may have crept in- after all I am just a volunteer.