Understanding Greeks

except for the typical ET juvenile name tossing..this is a decent thread. And one that I might be interested in.

Crimson started out with a inquiry about greeks. Many have said that greeks are important but none have provided a solid example as to how greeks will affect his or any position.

Crimson might, and I certainly will, go out and purchase an options book this weekend.
Maybe until that time comes someone can give an example of a good trade using current pricing. Maybe a bear call spread on the SOX.

Lets keep this thread going for educational reasons. Not for a sword fight.

Trade Well.
uptik2000:cool:
 
Try to think of the greeks this way. Say I hand you a bomb. I tell you that I will pay you $1000 a minute for every minute that you hold it. How long are you willing to hold it before you give it back to me knowing it could go off any second? That is where the greeks come in. If you don't know when that bomb is going to go off, then you just made yourself a really bad bet.
 
Learning to apply the greeks will take time and effort. The best books for defining the interrelationships are by Natenberg and Hull. Baird is a good in showing how they apply to various trading strategies. Howevever, none are easy weekend reads. I suggest you also read Maverick74's thread on the optimal trading position on this board. Mav goes into great details about using the greeks to construct a trading strategy. He even provides a fully worked example with pictures and numbers. The example he cites is complex but covers the ground well and the concept can be applied to your bull spread.

Bull sprd change signs twice (bimodal) with price movement. When the price of the underlying is near to your long position you'll have -theta, +vega, +gamma. This means that time is working against you and you want IV to increase (Natenberg tells you that ATM strikes have a higher vega than ITM or OTM and therefore will be more affected by the increase/ decrease in IV). Similarly, you'd like a large price movement in your favour at which point your long, which has a larger gamma that your short, will experience a greater growth in delta that your short position. The situation reverses when the share price in near to the short position. Then you'll be +theta, -gamma and -vega: the passage of time is your friend, you want little or no price movement and you pray that IV will remain flat or decrease.

The message is that the greeks tells an important story. The story becomes more important when it comes to adjusting positions (e.g., morphing your bull sprd into a bfly) or placing combination trades in the same or different months. They will also indicate your exposure to risk. I've seen may trades where the risk:rewaed graph is a beauty but the greeks tell that the position is very unstable (high gamma).

I've given a brief description to a very complex subject. Further study and application are necessary. However, I hope I have provided a useful starting point.
 
Crimson,

With all do repsect to all of the people that have replied to your thread I would have to say having at least a basic understanding of the greeks would only benefit you. Whether or not you use them is another story.
I would highly recommend McMillan's book Options as a Strategic Investment, and further you can use the Options Industry Council where you can actually speak to someone taht can answer your questions over the phone.
With that said.......trading spreads does require one to have an intimate knowledge of Vega(volatility) plus volatility and how those items would effect your position especially if your spreads are directionally biased. Case in point, I established a combination straddle on RIMM before they released their earnings. Vega(how much an option will change in price relative to the change in implied volatility) was around .05/contract and implied valatility was near 99, which was 45% higher than its 30 day historic volatility(so I found out later). Long story short RIMM released positive results, but less than expected. Stock moved down several points, but because the implied volatility fell back down to around 45 my trade was immeadiatley a loosing trade by a large percentage. So it is important to understand not only the greeks but also volatility.
 
This thread is very interesting and educative.May I ask two questions?Please reply

(1) Where do I find all the greeks -paid or free - for option positions?


(2) I mostly write covered call options and sometimes naked puts at a much lower price than the share price and always for a month. Can Greeks help me to improve on my trades and simply how. I try to pick shares for covered call mostly above 50 bn market cap.

Thanks
 
I don't think the Greeks work any better than the various indicators that stock and futures day traders stare at all day. For those in the dark, the former are related to option pricing formulas which give a guess for an option's fair value (FV) at a point in time, as a function of the current value of the underlying, the unknown standard deviation (volatility) of a normal distribution representing the return of the underlying at expiration, the strike, the time to expiration, and the riskfree rate of borrowing money.

Delta and gamma are the first and second partial derivatives of the FV with respect to the underlying price, theta is the first partial derivative wrt time, vega is the first partial wrt volatility and rho is the first partial wrt the riskfree rate.

Except for rho, these numbers usually vary wildly during the life of an option. It is generally believed that successful option players use them to enter and modify spreads during the time they hold them. Academic studies proving this are lacking. Delta, gamma and theta are additive among the elements of a spread. For example, constantly changing a net short position to try to maintain delta and gamma = 0, is an attempt to make money on time decay, even though you don't have a handle on where the underlying will end up.

What I am most convinced of is that having a good handle on where the underlying will end up at expiration, knowing the profit loss curves for various option plays, and money management techniques will prove to be more important for success than constant fiddling with positions, using the Greeks.
 
If I use software like optionvue won't the graphical display of different strategies be sufficient(even if I don't know greeks) to decide on a suitable trade?
 
Quote from roberk:

If I use software like optionvue won't the graphical display of different strategies be sufficient(even if I don't know greeks) to decide on a suitable trade?
More...

In some ways, I suppose it would; however, the greeks provide an insight that a graph doesn't provide (at least to me): The greeks show you where the real risk is in a position; they may not necessarily be as important in basic, straight-forward strategies, but as you move into more complex strategies and hedging/adjusting positions (especially using options), the risk graph alone could very well lull you into a false sense of security. I'm still new to options so I don't have quite as much use for the greeks, but even just trading simple verticals, I find they provide a deeper understanding of the reality of the position.

Just my opinion...
Steve
 
As an ex MM on the Amex and CBOE the greeks were essential.
As a speculator they are not so important for directional plays and even vol spreads when they do not involve much capital...the geeks will dispute this as they love their programs that do not involve emotion...check out the real distributuitions.

It sounds like you have trading discipline...keep it.

Vol spreads are ...PM me
 
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