Predicting the movements of options is not that easy. It is not just the price of the underlying asset; but there are many other factors that contribute to the movement of the price of an option. The overall outcome of the option positions are a result of the changes in the market positions. There are several factors that determine the price of an option and this helps one determine the impact they have.
If you have heard you stock broker or stock advisor using the terms ‘gamma’, ‘delta’, ‘theta’, ‘rho’ or ‘vega’ to determine positions, then don’t rush up to enroll for Greek lessons. It’s a fairly simple concept that quantifies the sensitivity of the option positions. Ideally, the Greek terms that are used, usually denote the risk of the option and the reward that can be expected from that position.
Commonly known as Option Greeks, it revolves around the study of picking out the right Option for the right price. These Greeks give an indicative price to arrive at a target price to incur profits and also to arrive at when to minimize losses by giving up a position.
Delta: This Greek has a direct relationship with the movements related to the underlying share price or index. In other words, it helps us understand whether an option price is going to change because of the change in the underlying asset (which is an index of the stock). So, if we assign delta for an option price as 0.15, then the change in the underlying price of the stock by Re. 1 would indicate an increase in the Call option by 0.15.
Gamma:This is the rate of change in the delta for every change in the underlying price. In this case, if there is a change in the delta by an increase of Re. 1 in the underlying price of the stock, then the rate at which the delta has changed is measured.
Theta: As the value of an option reduces, it comes closer to its expiry date. Theta helps measuring the gradual change in the option as it approaches its expiry date or comes closer towards the zero value. With this, the theta measures the effect of the passage of time on the option price.
Vega:The overall impact of volatility on the Option price is measured by Vega. The implied volatility directly affects the option price making it rise and fall. Hence, if the implied volatility of the stock increases, then it is likely that the option price will also increase and vice versa if it declines.
Rho:Rho measures the impact of the overall interest rates on the option price. This is not always measured, as the impact on the option price is minimal.
It’s important to also note that Option Greeks cannot be easily calculated by anyone, it requires several advanced mathematical calculations. These are not easily found in the daily newspapers. One can find an Options calculator within financial websites; these have the fields such as spot price, time of expiry and other factors that govern the calculation of delta, gamma, theta, vega and rho.
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