Is the value of your options contract changing? The options greeks measure how changes in the underlying’s price, time, and implied volatility can affect the value of options.
There are several different ways to measure how sensitive options are relative to the price of the underlying, the passage of time, and other factors, and many are represented by a letter of the Greek alphabet. Thus, these types of measures are often referred to as the Greeks.
Delta measures options’ sensitivity to changes in the price of the underlying asset. Delta ranges from -1 to 1.
Call options have a positive relationship to the price of the underlying and will approach 1 the further in-the-money the option is. A delta of 0.5 means that if the underlying stock increases by $1, the call option is expected to increase by $0.50.
Conversely, put options have a negative, or inverse, relationship to the price of the underlying and approach -1 the further in-the-money they go. A put option with a delta of -0.6 is expected to increase in value by $0.60 if the underlying security decreases by $1.
Theta measures options’ time sensitivity, or more specifically, the impact of time on the price of the option.
Theta indicates how much the price of an option is expected to decrease over a certain period of time, usually expressed over a one-day period. Theta increases as expiration gets closer because the price of the option declines exponentially as expiration approaches. Time is generally expressed as T plus the number of days the option has been in effect. For example, T+0 (the day the position was opened) would have a very low theta, while on day T+13 of a 14-day contract, theta would likely be very high. If theta is, say, 45.75 at T+7, it means that on the seventh day of the contract, the option is losing value at a rate of $45.75 per day.
The following graph shows a general depiction of the way theta increases as the expiration date approaches.
This illustration is hypothetical and does not reflect actual investment results, transaction costs, or guarantee future results.
Vega measures how sensitive options are to changes in implied volatility.
Before tackling implied volatility, it might be helpful to brush up on the concept of historical volatility as it relates to investing. Volatility measures how much and how quickly the value of a security or market sector changes.
Implied volatility, on the other hand, is a more complex measurement that is used in the options pricing model. It combines historical volatility, current market conditions, and future expectations for a particular stock to estimate future price volatility. Generally, implied volatility responds to public perceptions of the market and typically increases in bearish markets (which are sometimes considered to be more uncertain) and decreases in bullish markets.