Section 3: Understanding the greeks
The terminology for futures option trading is universal to the option universe and the primary terms are known as the greeks.
The Greeks are a group of concepts that help describe an options characteristics so they are more readily understood.
Delta is the amount of price movement an option will have in relation to the underlying market. Options that are in the money will go up or down in close proportion to the underlying market and would be said to have a delta of one. Options that are far out of the money may not go up much at all in relation to the market so they would have a very low delta. Notice how the 1400 options were worth more than the 1500s. If the market were to go up 50 points in a day, the 1400 calls would go up in value by almost 50 points but the 1500 calls may only be worth 20. Even though they quadrupled in value, they only experienced about 22% of the 50 point move (15 point price increase from 5 to 20.)
If a futures contract moves $1,000 and the option has a delta of .20 then it would go up by $200, a delta of .50 would be $500 and so on.
Gamma is the rate of change in the delta. The previous example looked at the 1400 and 1500 Jan options. The 1400 options had a delta of almost 1.o and the 1500 calls were .22. Another 50 point day would bring the 1500 options in the money so the gamma would reflect the fact that they now have a much higher delta then when they were deep out of the money.
Theta is one of the most important concepts as it's the source of loss for many option buyers. Theta is the mathmatical representation of time decay. If you refer to the option pricing table you will notice that the more time an option has, the greater its worth. In another example we could imagine that the S&P does not go up or down for each of the next three months. In this scenario, the options would decay in price as the life of the options pass. In a months time the January 1450 puts would go to zero and expire worthless, the Feb options would be worth about 5 and the March, 15. In the month that passed, the February 1450 calls lost 15 points of value. Dividing that out over 20 trading days, that means that the holder lost almost one tick a day due to time decay, or Theta.
Vega is an expression of how much an options price is affected by a change in the volatility of the underlying market. Using the same example as that for Theta, we could see an economic event unfold that could increase the probability of a giant move in the market. This potential for a move could potentially offset the time decay of an option and make it go up over time, all other things being equal.
Futures-Option-Trading.com
1: Futures option trading basics
2: How to price futures options
3: Understanding the Greeks
4: Using option spreads
5: Synthetic options and futures
6: Strategies
7: Tips for buying and selling
8: Risk Disclosures for options
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