Demystifying Options: Know Your Greeks
Meet the "Greeks"
Delta, Gamma, Theta, Vega and Rho - you are likely to hear these "Greek" risk measures whenever traders talk about options. Although these terms sound complicated, they actually are easy to understand once you grasp a few basic concepts.
Mastering them will give you a good understanding of why options behave the way they do under different circumstances.
Delta - Based on the Odds
Delta or Change per Point is the option’s sensitivity to a small change in the stock. For instance, if the stock moves by $0.10 and the option changes by $0.05, then the option is said to have a Delta of 50, meaning that it in dollar terms it matches 50% of a the move in the stock.
Conceptually, Delta is related to the probability that an option will end up in-the-money. In the top two parts of Table 1, we show premiums and the Deltas at various stock prices of a call with a $100 strike price and with different lengths of time to go before expiration: 182 days, 91 days and just five days to go before expiration.
Looking at Table 1, notice that with only five days to go, if the stock price is $80, the Delta of the $100 strike call is 0. This is because there is virtually zero likelihood that the call will end up above $100 - i.e. in-the-money.
If the stock price is $120, then the Delta is equal to 100, since there will be a virtual 100% likelihood that the option will stay in-the-money (i.e. end up above $100).
Finally, if the stock price equals $100 shortly before expiration, then the Delta will be close to 50. This is because there is 50% change that the stock will end up in-the-money and a 50% chance that it will end up out-of-the-money.
Now look at the call with 182 days to go. Notice that with the stock at $100, the odds are still reasonably close to 50/50. However, if the stock is equal to $80, the odds will be greater than zero - in this case 35% - that the stock could end up above $100. Alternatively, if the stock is at $120, the 80 Delta is generated by the 80% probability that the stock will end up above $100.
You can easily translate Delta into dollars. Here is an example: if you are long a call on 100 shares of stock priced at $100 (total underlying stock value $10,000) and the Delta is 50, then your equivalent position is $5,000 worth of the stock (or 50 shares).
Continued In Part Two...
Posted By: Value Line
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