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All You Need to Know About the Option Greeks

14 Sep 2023

Introduction:

Options trading is considered one of the most risky and challenging forms of trading in the stock markets. The prices of options contracts can increase or decrease suddenly, inflicting high profits or losses on investors. For an options trader to become successful, several factors must work in their favor simultaneously.

These factors are collectively known as the Options Greeks. Experienced options traders understand these factors and use them to determine the risk-return potential before buying or selling an options contract.

As a rookie investor, you must learn about the Options Greeks to make more informed trading decisions. This article explains the meaning of Options Greeks, types, and significance in detail. Keep reading.

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Understanding Options Trading

Before learning about Options Greeks, you must understand what Options are. An options contract gives you the right (but not the obligation) to buy or sell a specific quantity of the underlying securities at a pre-determined price (known as the strike price) on or before an expiry date.

Based on your speculations of whether the price of an asset may rise or fall, you can trade in options contracts to make high profits from favourable market movements. If speculate an asset's price can go up soon, you can buy a Call Option. Similarly, if an asset's price can decline, you can buy a Put Option.

The premium is the price you need to pay for buying an options contract. This premium keeps fluctuating until the options' expiry date based on several parameters discussed below.

What are Options Greeks?

Options Greeks are the set of parameters used to measure various factors that can impact the premium of an options contract. They help the investors determine how an options contract reacts to different parameters that can influence its premium and make informed trading decisions.

Options Greeks are variables depicted through five Greek letters – Delta, Gamma, Vega, Theta, and Rho. Keep reading to know what each of them represents:

  • Delta

Delta refers to the degree by which an options premium moves with the change in the underlying asset's price, given that all other parameters remain constant. The value of the Delta ranges between -1 to 0 for Put Options and 0 to 1 for Call Options.

For instance, suppose an options contract has a Delta value of 0.5. It means that when the price of the underlying asset increases by Re. 1, the premium for the Call Option rises by 50 paise. Similarly, when the price of the underlying asset declines by Re. 1, the premium for the Put Option decreases by 50 paise.

  • Gamma

Gamma indicates the change in the value of Delta relative to a change in the underlying asset's price. Thus, it helps determine how fast the Delta of your Options contract changes with the change in the market price.

The value of Gamma increases for At-The-Money (ATM) options and decreases for Out-of-the-Money (OTM) options.

  • Vega

Vega measures how much an options premium changes relative to the volatility in the underlying asset. For example, if the value of the Vega for an options contract is 0.25, the options premium can change by 25 paise when there is 1% volatility in the underlying asset's price. Vega is maximum for ATM options and minimum for OTM options.

  • Theta

Theta measures how much the value of an options contract may decrease as it approaches its expiry. It is also known as the option’s time decay. For instance, if an options contract has a Theta value of -0.70, its premium will decline by 70 paise every day till expiry, given that all other parameters remain constant.

  • Rho

Rho measures the impact of the changes in the interest rate on the value of an options contract. For instance, if an options contract has a Rho value of 0.10, its premium would rise by 10 paise for every 1% increase in the interest rate and decline by the same value for every 1% decrease in the interest rate.

To conclude

Understanding Options Greeks can help you speculate movements in options premium and enter or exit trading positions accordingly. These are constantly changing variables, with the change in one variable likely to impact all other variables. With Motilal Oswal, you can open a Demat account and get intelligent investing tips for free.

 

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