Options Greeks Explained

When it comes to options trading, some traders may make the mistake of thinking that the underlying asset’s price is the only factor that impacts options prices. However, the option's price can shift while the value of underlying stocks stays the same. This is where the Greeks come in.

You may have heard a lot about Greeks and trading, but unlike common associations, they have nothing to do with college campuses or ancient philosophers. Instead, the Greeks are used to measure an option's price sensitivity in relation to underlying parameters, including the value of underlying assets or volatility. Options traders utilize the Greeks regularly, using them as a set of variables that help measure a number of factors that drive movement in option premiums (contract prices).

If traders understand how shifts in price can impact options, they may have more potential for finding success. To do this, traders will need to pick the Greeks that work with their strategy, as some Greeks may work with one trading strategy, while others tend to work with another.

In this article, you’ll find the following options Greeks explained:

• Delta

• Gamma

• Vega

• Rho

• Theta

We also include a helpful options Greek cheat sheet.

What are the Greeks in options?

Technically speaking, the Greeks are all measures of sensitivity of the variable inputs of an options price model. Each Greek displays a particular variable that can impact an option’s contract price. Using mathematical formulas, the Greeks show how an option's price would potentially move depending on how that specific variable changes.

Delta

Delta measures how much an option’s price will change based on a $1 move in the underlying asset value. In other words, it is typically used to show the approximate probability an option will expire in-the-money. For example, a call option with a delta of 0.2 has approximately a 20% chance of ending up in-the-money.

Delta is also known as the “hedge ratio” because some traders will use it for more than just measuring an option’s price variation. These traders will use delta to first determine whether they want to buy or sell the underlying asset.

Calls have positive delta, between 0 and 1. That means if the stock price goes up and no other pricing variables change, the price for the call will go up. The opposite is with puts, which have a negative delta, between 0 and -1.

Gamma

Gamma is a unique Greek because it isn’t used to measure the option’s price change, but rather how much the option’s delta may shift based on a $1 change in the underlying asset’s price. While an option’s delta will constantly shift to match the underlying price changes, the gamma can help traders better understand where the delta could go based on price changes for the underlying security.

If the gamma is high, the delta is more sensitive, and the option is more likely to experience a larger price change. Because of this impact, traders often use gamma to gain insights into the stability of the measurements provided by the delta.

Theta

While gamma and delta describe options price changes based on underlying stock prices, theta represents an option’s rate of time decay. This measurement describes how much the value of an option will decrease each day it gets closer to expiring, assuming that all other factors remain the same.

Vega

Vega helps measure the sensitivity of the option’s price in relation to implied volatility. Implied volatility represents the predicted amount of price variation (volatility) a stock could undergo during the life of an option. The Vega value can be applied with a simple formula: the derivative of an option's price divided by the derivative of the volatility of the underlying. The value of Vega will be higher the closer the stock price is to the strike price but also decrease as the expiration nears.

Rho

Instead of measuring how much the option’s price will change based on underlying stock prices, rho measures how much the price may shift in relation to the risk-free interest rate used for pricing the contract. A longer-term call option that has a higher-priced underlying asset will have a higher rho value.

Rho does not have as significant of an impact on option prices compared to other Greeks, but its impact will increase the further away an option's expiration is due to the cost of carry.

Options Greeks Cheat Sheet

In the helpful cheat sheet that we provided, it shows the value for long or short calls and puts. The Greek with a "+" in a call or put column will be positive with that strategy, and the Greek with a "- "will be negative with that strategy.

Let's look closer at how delta would show in regard to the cheat sheet. The greater positive a delta is, the closer it is to representing the price movement of the underlying asset, and the more bullish your position is. And the more negative the delta is, the more bearish or in-the-money your position is. If the delta has a value close to zero, it indicates a more neutral position or that the option has little worth.

To better understand how each Greek behaves and what it measures, keep reading.

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Keep in mind, option Greeks are calculated using options pricing models and are theoretical estimates. All Greek values assume all other factors are held equal.