The amount of data you are greeted with upon attempting your first options trade can be intimidating. What does it all mean; and where do I begin? This article will hopefully serve to help you understand the Greeks (Delta, Gamma, Theta) better than you did before. Please note there are other minor greeks not covered in this article.
What are the Greeks and what purpose do they serve?
Delta, gamma, and theta are the three main Greeks and provide a way to measure the sensitivity of an option’s price to various factors. Essentially consider each options contract as an individual entity. The Greeks are a way to measure the statistical probabilities of a profitable outcome if you purchase the contract. Like a manager in baseball looking at the bench and picking a pinch hitter that would have the best odds of driving in a run.
Delta: Variability of an Option Contract’s Value
Delta is the amount the option price is expected to move based on a $1 change in the underlying security. Delta measures the variability of an option’s value depending on the price action of the underlying security. It’s a way to measure the amount an option price is expected to change.
“As an alternative convention, the delta can also be shown as a value between -100 and +100 to show the total dollar sensitivity on the value 1 option, which comprises 100 shares of the underlying. The normalized deltas above show the actual dollar amount you will gain or lose. For example, if you owned the December 60 put with a delta of -45.2, you should lose $45.20 if the stock price goes up by one dollar.”
https://www.investopedia.com/trading/using-the-greeks-to-understand-options/
Gamma: Change in Delta Over Time
Gamma measures the change in delta over time. This is meant to give a trader an idea of how the options contract price has changed according to the movement of the underlying asset. This can give traders a better idea of what to expect in the future.
“Gamma will be larger for at-the-money options and goes progressively lower for both in- and out-of-the-money options. Unlike delta, gamma is always positive for both calls and puts.”
https://www.investopedia.com/trading/using-the-greeks-to-understand-options/
Theta: Measuring the Time Value of an Option
Theta is a measure of the time decay of an option. A lot of the value in an option contract is based on the amount of time remaining until expiration. The more time remaining, the more valuable the option contract is. It’s similar to a young promising professional athlete. A general manager will get more money for a 20-year-old running back in his prime. Compared to a 30-year-old running back who has already gained a ton of mileage. For at-the-money options, theta increases as an option approach the expiration date. For in-and out-of-the-money options, theta decreases as an option approaches expiration. Time decay tends to accelerate as the expiration date of an option draws closer because there’s less time left to earn a profit from the trade.
Theta is always negative for a single option since time moves in the same direction. As soon as an option is purchased by a trader, the clock starts ticking, and the value of the option immediately begins to diminish until it expires, worthless, at the predefined expiration date.
“Theta is good for sellers and bad for buyers. A good way to visualize it is to imagine an hourglass in which one side is the buyer, and the other is the seller. The buyer must decide whether to exercise the option before time runs out. But in the meantime, the value is flowing from the buyer’s side to the seller’s side of the hourglass. The movement may not be extremely rapid, but it’s a continuous loss of value for the buyer.”
https://www.investopedia.com/trading/getting-to-know-the-greeks/