Practicalities of Option Greeks

[SunnyBhoy]

Hi,

New to Options but stock trading for a few years now. For the last 2 days I've been watching endless videos, reading websites and failing miserably to fully understand the Greeks - not the theory but the practicality of them - very few people seem to give concrete examples of how they actually use the Greeks.

OK so I'm going to ask a really simple question and hopefully get a reasonably simple answer. Say I am interested in company 'ABC' which has a current stock price of $100. I'm convinced the price will go to at least $120 within the next month. So I decided to buy a Call option. The question is what would your tactics be in buying the Call? Do you go near, out or in the money and what do you use the Greeks for when deciding what Strike price to buy at?

TIA

 

[Robert Morse]

The Greeks are used to see where your risk is, not to decide which call to buy. This would be much easier to help you over a short phone conversation then me typing a really long response. If you email me your name and phone number, I'll can give you a call this morning before the open.

 

[panthers01]

Go one step back, the Greeks are derived from the Black-Scholes formula to calculate a fair value of an Option. That means every time a Greeks changes the price of the option also changes. when comming to practicalities for beginners, consider vega, delta and gamma.
Vega tells you how much the price of the options will react to changes in valatility.
Delta shows how much your options price will move when the underlying price moves, you can see it also as
the change, that the option will be profitable.
Gamma tells you how much value your option will lose per day.

Back to your question. Option trading is about probabilities and there is no simple answer to your question. Here are a few possibilities, you can consider with your setup.
every option trader, worth his salt would ask: whats the volatility, lets assume something around 30%.

1. you could buy a deep ITM call option, maybe Call 70 and profit 1:1 from the move, con: the option will be very expensive, and if it goes below 100, your will lose 1:1. but based on your risk appetite your just can buy 1 lot.

2. You could by a Call at the money, which would be much cheaper, but you would not anticipate as much from the move at the beginning. If you would hold the options until expiration you would get 20 * 100 per Lot, but if the stock ends with 99, you will lose 100% of your bet.

3. the same as 2 but you but an Option wide out of money, let say 115, which will be very cheap and if your price really goes to 120 you will earn 5*100 per lot ,here you would be able to buy much more lots.

4. If you think the price will go until 120 and not more, you could do a spread, that means you buy a call 100 and sell a call 120, that makes you investment smaller but also you max profit.

many more possibilities....

But here comes the funny part: if the underlying price does not change, you will lose money every day, based on Gamma. If the price does not change or goes up slowly, your option will lose value because of lower Vega.

The moral of my post: if you guess the market right, the greeks are not that important. But if you are wrong, they get the more important.

 

[lindq]

Hi,
The question is what would your tactics be in buying the Call? Do you go near, out or in the money and what do you use the Greeks for when deciding what Strike price to buy at?

TIA

You will find this site helpful: http://www.investopedia.com/articles/optioninvestor/03/021403.asp

I focus most on Delta when I take a long call or put position. Very simply, that indicates the amount that the option is likely to change in relation to the underlying.

Everything else being equal, when I buy a call or a put and pay the spreads for an option, I want a decent bang for my buck. Otherwise, I'll just buy the underlying.

Which leads me to advise you: If you are consistently profitable trading stocks, then options may be of value to you. Otherwise, options will increase your losses.

 

[stepandfetchit]

Go one step back, the Greeks are derived from the Black-Scholes formula to calculate a fair value of an Option. That means every time a Greeks changes the price of the option also changes. when comming to practicalities for beginners, consider vega, delta and gamma.
Vega tells you how much the price of the options will react to changes in valatility.
Delta shows how much your options price will move when the underlying price moves, you can see it also as
the change, that the option will be profitable.
Gamma tells you how much value your option will lose per day.

Back to your question. Option trading is about probabilities and there is no simple answer to your question. Here are a few possibilities, you can consider with your setup.
every option trader, worth his salt would ask: whats the volatility, lets assume something around 30%.

1. you could buy a deep ITM call option, maybe Call 70 and profit 1:1 from the move, con: the option will be very expensive, and if it goes below 100, your will lose 1:1. but based on your risk appetite your just can buy 1 lot.

2. You could by a Call at the money, which would be much cheaper, but you would not anticipate as much from the move at the beginning. If you would hold the options until expiration you would get 20 * 100 per Lot, but if the stock ends with 99, you will lose 100% of your bet.

3. the same as 2 but you but an Option wide out of money, let say 115, which will be very cheap and if your price really goes to 120 you will earn 5*100 per lot ,here you would be able to buy much more lots.

4. If you think the price will go until 120 and not more, you could do a spread, that means you buy a call 100 and sell a call 120, that makes you investment smaller but also you max profit.

many more possibilities....

But here comes the funny part: if the underlying price does not change, you will lose money every day, based on Gamma. If the price does not change or goes up slowly, your option will lose value because of lower Vega.

The moral of my post: if you guess the market right, the greeks are not that important. But if you are wrong, they get the more important.

ERRATA with your info on "gamma": Replace word "gamma" with "theta".

 

[panthers01]

ERRATA with your info on "gamma": Replace word "gamma" with "theta".

thank you for the correction, to remember the Greeks:
Theta => T ime
Vega => V olatility
Gamma => Gas (acceleration) of Delta
Delta => Delta per Underlying change

I know the last one is a little bit lame

 

[SunnyBhoy]

Thanks Lindq much appreciated. I'm doing OK with stocks but keep thinking I'm missing something with Options. I concentrate most of my energy on money management and I love the idea of a finite loss with an Option contract. However I can't balance the attractive idea of a more leveraged trade in Options with the thought of losing the time advantage stocks give me. As always with trading it's all interesting stuff!

 

[SunnyBhoy]

The Greeks are used to see where your risk is, not to decide which call to buy. This would be much easier to help you over a short phone conversation then me typing a really long response. If you email me your name and phone number, I'll can give you a call this morning before the open.

Thanks Robert, the only problem is I'm in Australia hence my delay in replying! You have mail.

 

[SunnyBhoy]

Go one step back, the Greeks.

Thanks panthers01. To be honest I was expecting a raft of 'go away and read a book' replies and I'm very grateful for your extended answer. It's the same problem I had at University (although I think they've improved now), I felt they taught far too much theory with not enough practical experience. It's that Haha moment I'm looking for, seeing what experienced Option traders actually do with the Greeks on a day to day basis. Your reply has helped a lot.

 

[lindq]

Thanks Lindq much appreciated. I'm doing OK with stocks but keep thinking I'm missing something with Options. I concentrate most of my energy on money management and I love the idea of a finite loss with an Option contract. However I can't balance the attractive idea of a more leveraged trade in Options with the thought of losing the time advantage stocks give me. As always with trading it's all interesting stuff!

The only way you'll learn the details of options trading, and whether it will benefit you, is to do it. There is no education like experience. Just open no more than one contract at a time, and keep careful records.