Option Greeks -
A Qualitative Explanation

Option Greeks

They are essentially a set of different measurements that help to determine the option’s risk exposure with regard to different parameters such as time, interest rates, volatility etc. Below are the qualitative explanations:

Delta

Delta is possibly the most important of the option greeks and is often expressed in %, is the ratio of rate of change in the option with respect to per unit change in the underlying stock. Example: if the stock moves by $1 and the corresponding move in the option is $0.30, it means that the option has a Delta of 0.30. Knowing the effect of Delta is important towards your trading success especially if it is used as an instrument to hedge an underlying position.

Gamma

Rate of change in Delta, i.e. change in the delta of an option with respect to the change in price of the stock. Gamma is at the highest level when the option is at-the-money and become increasing lower as the option has become further out-of-money or in-the-money.


Theta

A measure of the change in the price of the option with respect to the time decay of the option. Theta whittle away faster when it is nearer to expiration and more slowly for option with longer time to expiration.

Vega

To understand Vega, you will need to first understand implied volatility. Implied volatility basically refers to the estimated volatility of a stock price. Implied volatility increases when a stock is bearish. This is due to the fact that in downward movement, the fluctuation of the stock is higher as compared to upward movement. Vega essentially refers to the rate of change of option premium with respect to one percentage change in the implied volatility. For long term options, Vega can work to your advantage or disadvantage depending on the volatility. Therefore, you really want to purchase an option when it is under priced, i.e. when Vega is low and take the opportunity to sell when Vega increased.

Rho

Rho is essentially the sensitivity of the option price with respect to per unit interest rate change. It is a less critical measure as compared to the other option greeks, in part due to gradual interest rate change.

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