When we buy a stock with common shares, everything is relatively straightforward. There is a bid and an ask, we place our order, as long as there is enough shares to buy/sell our order fills and we move on. With options, things get infinitely more complicated. All of a sudden rather than just factoring price, we have to factor in volatility, a time window, decay and several other factors into our trade. So what exactly are some of these factors? Which are more important, and which can help figure out our trade.
Delta is probably the most commonly known greek. It measures how much the option price will move with stock. A delta of .70 would mean that on a one dollar move on the underlying stock, the option pricing would move 70 cents. Now the delta is constantly changing (the other greeks tell us that). But knowing the delta alone can really help us navigate our overall risk reward on a trade and know how much we can expect the option pricing to move as we head towards our target, or away from it, and how we can place a stop on options.
Gamma represents that change that the delta will make when the stock moves. So, if when you buy your option the delta is .70, and the gamma is .03, as the price moves up (in the event of a call for example) the delta will move up .03 as the underlying moves up one dollar. So your option will not only go up, but as it continues to go up the option will go up at a faster rate than when you initially bought. The reverse works too with decay. If you bought with a delta of .70, and a gamma of .03 (this is a common rate of change for some SPY options) then if the move goes against you by 1 dollar, then your option pricing will drop, but then it will also start to drop more because of the gamma.
Vega is a little bit more complicated of a greek. It deals with implied volatility. As we’ve seen in trading, volatility is when the market starts making outsized moves very quickly, especially when it goes down very quickly. Options have some of that volatility baked into the price of the option, especially when the underlying is a very volatile stock. This implied volatility is the reason some options are incredibly expensive, and why when we’re seeing crazy high-flyers, the options pricing doesn’t really move much even when the parabolic stock starts to fall. The vega essentially tells us the rate of change of the option if the implied volatility were to change by 1%. Some more sophisticated option strategies can be built around volatility exposure.
Rho represents the rate of change of an option depending on a 1% move in US interest rates. When interest rates are higher, using options to hold a longer dated position that requires less capital will allow investors to collect interest on money that is not in stocks, so the underlying price of options can actually change as the interest rates also change. Rho is far more used in long dated calls/puts and generally wouldn’t be a huge factor in shorter term options trading.
Lastly Theta. One of the hardest things about trading options directionally (just going long or short as if they were common shares) is that you not only have to pick a direction for a move in a stock, but you also have to pick the time in which that outsized move can happen. Theta is the rate of decay on the option per day as it comes closer to expiry. When we buy options, we are paying a premium for time, as that time runs out, the premium runs out. This is theta. And this is why playing short term (0dte - day til expiry) or even weekly options sees decay happen so quickly even if a stock stays flat.
So, there you have it. The greeks. The options market, the buying, selling, covering, hedging is massive and has implications for the broader markets, hopefully this gives a little insight to all the stuff happening behind the scenes.
