Options Trading: What Are the Greeks?

TL;DR

The Greeks — Delta, Gamma, Theta and Vega — are financial calculations that measure an option's sensitivity to specific parameters. Delta (Δ) shows the rate of change between an option's price and a $1 movement in the underlying asset's price. Gamma (Γ) measures the rate of change of an options delta, based on a $1 change in the underlying asset's price.

Theta (θ) measures the sensitivity of an option's price relative to the time it has left to mature (or expire). Vega (ν) measures an option's price sensitivity based on a 1% move in implied volatility.

Introduction

Participating in derivatives trading requires more knowledge than in the spot markets. For options trading, the Greeks are among the most important set of new tools to master. They provide a basic framework for managing risk and help you make more informed trading decisions.

After familiarizing yourself with the Greeks, you'll be able to better understand options market analysis and take part in wider discussions on puts, calls, and other options topics.

What Are Options Contracts?

An options contract is a financial instrument that gives you the right — though not the obligation — to purchase or sell an underlying asset at a predetermined price (the strike price); it also has an expiration date. 

Options contracts fall into two main categories: calls and puts. A call option allows its holder to buy the underlying asset at the strike price within a limited timeframe, while a put option enables its holder to sell the underlying asset at the strike price within a limited time frame. An option's current market price is known as its premium, which its seller (known as a writer) receives as income.

You may have already noticed some similarities if you're familiar with futures contracts. Options offer both hedging and speculative opportunities, and the parties involved take opposing bearish and bullish positions.

You may want to lock in a specific price for an underlying asset to better plan your future financial position. You may also want to buy or sell the underlying asset at an advantageous price based on a predicted price movement.

What Are the Different Greeks?

In options trading, you'll regularly find discussions on the Greeks. These financial calculations measure an option's sensitivity to specific parameters, such as time and volatility. The Greeks help options traders make more informed decisions about their positions and assess their risk. There are four major Greeks used in options trading: Delta, Gamma, Theta, and Vega. 

Delta (Δ)

Delta (Δ) shows the rate of change between an option's price and a $1 movement in the underlying asset's price. The calculation represents the option's price sensitivity relative to a price movement in the underlying asset.

Delta ranges between 0 and 1 for call options and 0 and -1 for put options. Call premiums rise when an underlying asset's price increases and fall when the asset's price declines. Put premiums, on the other hand, fall when the underlying asset's price rises and rise when the asset's price drops.

If your call option has a delta of 0.75, a $1 increase in the underlying asset's price would theoretically increase the option premium by 75 cents. If your put option has a delta of -0.4, a $1 increase in the underlying asset's price would decrease the premium by 40 cents.

Gamma (Γ)

Gamma (Γ) measures the rate of change of an options delta based on a $1 change in the underlying asset's price. This makes it the first derivative of delta, and the higher an option's gamma, the more volatile its premium price is. Gamma helps you understand the stability of an option's delta and is always positive for calls and puts.

Imagine your call option has a delta of 0.6 and a gamma of 0.2. The underlying asset’s price increases by $1, and its call premium by 60 cents. The option's delta then also adjusts upwards by 0.2 to 0.8.

Theta (θ)

Theta (θ) measures the sensitivity of an option's price relative to the time an option has left to mature (or expire). More specifically, an option's theta shows the premium price change per day as it moves towards expiration. 

Theta is negative for long (or purchased) positions and positive for short (or sold) positions. For the holder, an option's value always diminishes over time ceteris paribus (provided all other things are equal); this applies to both call and put contracts. If your option has a theta of -0.2, its price will change by 20 cents daily the closer it reaches maturity.

Vega (ν)

Vega (ν) measures an option's price sensitivity based on a 1% move in implied volatility. It relies on a calculation of implied volatility, the market's forecast of a likely movement in the underlying asset's price. Vega is always a positive value because as an option's price increases, its implied volatility also increases ceteris paribus. 

In general, higher volatility makes options more expensive because there is a greater likelihood of meeting the strike price. An options seller will benefit from a fall in implied volatility, while a buyer will be disadvantaged. Let's look at a basic example: if your option has a vega of 0.2 and the implied volatility rises by 1%, the premium should increase by 20 cents.

Can I Use the Greeks for Cryptocurrency Options Contracts?

Cryptocurrencies are commonly used as underlying assets with options. Using a cryptocurrency makes no difference when calculating or using the Greeks. However, do note that cryptocurrencies can be highly volatile, which means that Greeks dependent on volatility or direction can also experience large swings.

Closing Thoughts

With the four major Greeks mastered, you'll be better equipped to assess your risk profile at a glance. Options trading has a relatively high degree of complexity, and understanding tools like the Greeks is essential to trading responsibly. Furthermore, the four Greeks covered here aren't the only ones that exist. You can continue your options studies by exploring the minor Greeks.

Further Reading

• What Are Perpetual Futures Contracts?

• What’s the Difference Between a CEX and a DEX?

• What Are Forward and Futures Contracts?

• What Is the Risk/Reward Ratio and How to Use It

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