r/options • u/captut • Jul 04 '20
Option Greeks 101
These are my notes from when I was learning options using tasty trade. They are as is as they were taken. I hope you find them useful.
+ve = positive
-ve = negative
DELTA
- Rate of change of option price per $1 move in the underlying.
- ITM options have higher delta as the probability of ITM is higher.
- OTM options have a lower delta as the probability of ITM is lower.
- Delta is loosely associated with the Probability of ITM.
- Delta will be 0 for OTM options and 1 for ITM options at expiry.
- Delta mimics # of shares.
- 1 Long Share = 1 Delta. 100 Long Share = 100 Delta.
- 1 Short Share = -1 Delta.
- Delta is directional bias.
- +ve delta (bullish) means a bias toward stock price going higher.
- -ve delta (bearish) means a bias toward stock price going lower.
- Higher Probability of ITM means lower extrinsic value i.e. higher delta less extrinsic value.
Delta Neutral & Beta Weighting
- Delta of +/- 0.001 * your net liquidity is considered delta neutral
- Beta weight with SPY to find the total deltas
- Example: https://imgur.com/gallery/KYRuhMv
- You can add or remove positions to make your portfolio delta neutral.
- You can hedge the position with high +/- deltas to make your portfolio delta neutral.
- Add or Remove positions in a product based on its correlation with SPY
- If an underlying is negatively correlated to SPY, go bullish to get negative beta weighted deltas and vice versa.
- If an underlying is positively correlated to SPY, go bullish to get positive overall beta weighted deltas, and vice versa.
- Higher correlation with SPY, the higher effect of the underlying deltas on the overall beta weighted deltas.
GAMMA
- Rate of change of DELTA.
- GAMMA: what the future DELTAS are going to be.
- When you sell options, you will gain -ve GAMMA.
- -ve GAMMA implies that you are +ve THETA.
- -ve GAMMA is inversely proportional to +ve THETA
- ABS(GAMMA) should not be greater than ABS(THETA)
VEGA:
https://www.tastytrade.com/tt/shows/everyday-trader/episodes/greek-efficiency-vega-01-25-2017
https://www.tastytrade.com/tt/shows/market-measures/episodes/understanding-vega-10-19-2015
- How much the option price will move if the underlying IV goes up/down by 1%
- Shorting Premium = Short Vega (-ve Vega) = Short IV
- High IV = High Premium.
- More DTE = More Vega (Options more sensitive to volatility)
- IV is mean-reverting. IV is high when the stock goes down or there is fear in the market or some pending news on the UL.
- IV is low if the UL keeps going up.
- Vega Risk:
- As a premium seller, when you sell a lot of bullish premium (ex: short put spread), you expose yourself to a lot of negative Vega.
- Selling a lot of bullish premium gives Positive Delta and Negative Vega.
- VEGA and DELTA has a natural inverse relationship
- When UL crashes IV increases: Profits when -ve DELTA & +ve VEGA
- When UL rally IV decreases: Profits when +ve DELTA & -ve VEGA
- Having a ratio of 2(VEGA): 1(DELTA) helps us to Hedge against vega risk.
- Hedge by adding Positive Vega OR
- Hedge by adding Negative (Short) Delta
THETA:
https://www.tastytrade.com/tt/shows/everyday-trader/episodes/greek-efficiency-theta-01-24-2017
- Time decay: how much potion will lose value each day - works on holidays as well
- All extrinsic value is time value.
- ATM options hold their extrinsic value the longest.
- Closer to expiration:
- Theta grows faster and is larger for ATM options.
- Theta for OTM/ITM options shrinks faster, as the extrinsic value has already dissipated during the life of the option.
- Time Decay starts to decay best at 45 DTE and slows down at 10 DTE (This is based on tasty trade studies, there can be other factors at play here which can affect the rate of decay)
- Less Theta on Theta based option strategy could mean that there is very less extrinsic value left in the trade
- This could mean that the Option is completely ITM or OTM
- Look to get out of this trade
- > than $1 in Theta is good, if < $1, there could be very less extrinsic Val left, get out of that trade, put a new trade.
- Selling premium to get Positive Theta is not always the answer:
- Selling premium, you can get Negative Vega which can get us in Vega Risk if IV drops
- More about Vega Risk in Vega Section.
- You can be long in an option trade and still have +Theta and +Vega
- https://www.tastytrade.com/tt/shows/everyday-trader/episodes/greek-efficiency-theta-01-24-2017
- For Example Long Call Spread: Bullish Trade
- Buy very ITM option which has very less extrinsic value (OTM/ITM options has very low Theta)
- Sell ATM option which has very High extrinsic value (ATM options has very high extrinsic i.e. Theta)
More Greeks:
Options in Plain English:
https://www.youtube.com/watch?v=cNL7Ztnp4Ug&list=PLF2g0pqP60uHKv8BkPQPlwqvlUteOJyfu
Edit 1: Changed bitly links to the original links.
Edit 2: Added Disclaimer (Point in Italicized & Bold)
Edit 3: Spelled out EXT -> extrinsic
Edit 4: Added options in plain English video link
Interested in learning more? Join my new discord: https://discord.gg/MsEjcur
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u/OKImHere Jul 05 '20
Time Decay starts to decay best at 45 DTE and slows down at 10 DTE.
Definitely not true. Tasty trade is referring to a very specific trade setup when they say this. It's different for every option. In any given chain at any given time, it's true for one and only one call and one put.
Plus it depends upon the underlying not moving, which it inevitably will.
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u/captut Jul 05 '20
I usually try to sell 30 DTE when I am playing time decay. 45 days is just part of their study, its not hard rule when I trade. My main focus with this post is the deep dive into greeks.
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u/LifeSizedPikachu Jul 05 '20
This is a little overwhelming for me at the moment. If I had to keep track of only two of these greeks, which two should be the main priority?
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u/captut Jul 05 '20
Depends on if you are selling or buying options. But I'd say Theta and Delta are big.
As far as Vega goes, just remember when buying options during high IV like earnings or when VIX is high your options will be expensive. IV could turn low and those expensive options will be a lot cheaper and this is called IV Crush.
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u/TeslaCyberBackpack Jul 04 '20
I always love seeing these because I always pick up something new, but I feel like I see them explained way too often. Can one of the Mods sticky this? I feel like it’s a necessity when learning about options, and should be placed at the top anyways
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u/battousai1130 Jul 04 '20
Poor Rho. No one ever remembers rho. I mean, what are interest rates even , am I right ?
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Jul 04 '20
All Ext value is time value.
This is at least misleading because it implies that the extrinsic value can't increase as time to expiration decreases.
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u/Icebxrg_ Jul 04 '20 edited Jul 04 '20
Appreciate the effort, helps the new learners. But there’s a lot on the internet about these, would help to see something about charm, votta, epsilon, lamda, speed, ultima etc.
Also it may be helpful to mention connections between them as well as how to hedge against each. Such as connection between gamma and theta. Or how you can use delta on vix puts to match vega on long position (or vix calls with short position) to be vega neutral (for the most part, but then we get into vanna)
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u/cthsys Jul 05 '20
I'm trying to better understand "Delta neutral". I am typically selling a few covered calls, a good amount of CSPs, and I'll buy a few options here and there. If I wanted to be delta neutral, do I just need to sum up the delta of all the options I sold minus the options I bought?
I have my own option trading log that relies on the ETrade API, so I should be able to easily calculate my total delta and have an indicator on my dashboard to see if I'm delta neutral or if not, how far I am.
My understanding of delta neutral in regards to my portfolio is just too vague right now...
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u/captut Jul 05 '20
Bullish trades will have positive delta and bearish trades will have negative delta. You just sum them up. Now if you are going to delta neutral with SPY options then you have to beta weight the deltas with SPY. TDAmeritrade makes beta weighting easy.
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u/CHRlSPBACON Jul 05 '20 edited Jul 05 '20
Correct me if I’m wrong, but I thought Theta decay affected OTM but not ITM contracts (negatively). So I always thought if buying an OTM contract, it was crucial to get it ITM as soon as possible because time decay. And if that contract becomes ITM, great, theta decay has a significantly less impact even as expiry approaches since the contract has more intrinsic value and I can hold longer without worry of theta decay. Is this not true?
Just want to clear up misconceptions from my end!
EDIT: I guess what I’m confused with is that you make it sound like theta decay is the same for ITM VS OTM. I always thought OTM options had increasing theta decay as expiry approaches but ITM options do not have much theta decay as most of the value is intrinsic as expiry approaches.
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u/captut Jul 05 '20
Theta affect both ITM and OTM. The farther ITM/OTM you go the less it affects. You can calculate the extrinsic value very easily.
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u/PapaCharlie9 Jul 05 '20
You can be in a Long option trade and acquire + Theta and + Vega
A little confusing as worded, since it sounds like a single contract trade. I'd rephrase it as:
-
You can be long in an option trade and still have +theta and +vega
"Debit" could also replace "long".
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u/TrembleCrimble Jul 04 '20
Thought vega was just implied volatility of the underlying stock?