Wikipedia: Finance Greeks Explained

In finance, “Greeks” are measures of the sensitivity of an option’s price to changes in its underlying parameters. They are essential tools for options traders and risk managers, helping them understand and manage the risks associated with option positions. Understanding these Greeks allows for more sophisticated trading strategies and hedging techniques.

Key Greeks

• Delta (Δ): Delta represents the change in an option’s price for a one-unit change in the underlying asset’s price. A delta of 0.50 indicates that the option’s price will increase by $0.50 for every $1 increase in the underlying asset’s price. Delta ranges from 0 to 1 for call options and -1 to 0 for put options. Delta is often interpreted as the probability of the option expiring in the money.
• Gamma (Γ): Gamma measures the rate of change of delta with respect to changes in the underlying asset’s price. It indicates how much delta will change for a one-unit move in the underlying asset. High gamma implies that delta is very sensitive to price changes, leading to potentially volatile option prices. Gamma is always positive for both call and put options.
• Theta (Θ): Theta represents the rate of decline in an option’s price due to the passage of time (time decay). Options lose value as they approach their expiration date, and theta quantifies this rate of decay. Theta is typically negative for both call and put options, indicating a decrease in value as time passes.
• Vega (ν): Vega measures the sensitivity of an option’s price to changes in the implied volatility of the underlying asset. Implied volatility reflects the market’s expectation of future price fluctuations. A higher vega implies that the option’s price will be more sensitive to changes in implied volatility. Vega is positive for both call and put options.
• Rho (ρ): Rho measures the sensitivity of an option’s price to changes in the risk-free interest rate. While generally less impactful than other Greeks, rho becomes more significant for long-dated options. It represents the change in the option’s price for a one-percentage-point change in the risk-free interest rate. Rho is positive for call options and negative for put options.

Using the Greeks

Options traders use Greeks to:

• Hedge Positions: By understanding the sensitivities of their options positions, traders can use other options or the underlying asset to offset specific risks.
• Assess Risk: The Greeks provide a quantitative measure of the potential losses or gains associated with changes in market conditions.
• Develop Trading Strategies: Greeks are crucial for implementing complex option strategies, such as straddles, strangles, and butterflies.
• Price Options: Along with other inputs, the greeks are often used in options pricing models such as Black-Scholes.

Mastering the Greeks is fundamental for anyone serious about options trading. While calculations can be complex, various software and online calculators are available to assist traders in quantifying and managing these critical risk measures.