The Greeks
This post will briefly introduce you to the greeks. These are various parameters that are used to represent the value of a stock option. Extended details will require individual posts for each greek. This is just an introduction.
Vega – Implied Volatility or IV
Implied volatility is the extrinsic value expressed as an annualized percentage of the underlying. How much is the stock expected to move based on the options pricing. For an ATM option with a $5 premium (extrinsic value), the expected move is $5 in order to make that option profitable at expiration. If the price of the underlying is $500, that is a 1% move of the stock. The 1% change is converted to an annualized number based on the expiration date of the option. Options with high IV are more expensive than options with low IV. IV has the greatest impact on an options value.
Theta
This is the amount of money that you will lose each day if all other factors remain the same. An option with a $10 delta will decline in value by $10 each day. Theta values rise exponentially as the expiration date approaches.
Delta
The value change for a $1 move in the underlying stock. An option with .50 delta will increased in value by $0.50 if the stock moves up $1.00. Delta changes assume that IV and the other greeks have remained consistent, otherwise the full value of delta will not be realized. This is frequently the case on shorter dated options, as price approaches support or resistance. Delta of all positions can be summed to get an understanding of how long or short your overall position is.
Gamma
Gamma represents the rate of change of delta as the underlying price moves. Specifically this is the amount that delta will change if price of the underlying changes by $1. As price moves closer to an ATM position gamma increases, causing delta to change more rapidly. Gamma has a very important role both in the value of an option as well as the overall impact of all options on the market at large. A condition known as a gamma squeeze can cause the price of the underlying stock to explode well beyond its market value.
Secondary Greeks – The greeks behind the scene
Vanna
Vanna measures the amount delta will change as IV changes. Little impact will occur with Vanna for OTM options. Options that are near the current underlying price can have a heavy impact from Vanna.
Charm
Charm is the amount that delta will change as theta changes. This change greater on near the money options and not so much on deep ITM or deep OTM options. As options near expiration the impact of charm will increase. This is very noticeable on the last hour of the day of expiration.