Greeks on LEAPS

TrailerParkTed · Aug 12, 2021

TheBigShort said:
Greeks are simply your exposures to certain changes in the world.
Delta -> your exposure to the change in the underlying price
Vega -> your exposure to the change in expected movement
Theta -> your exposure to the change in time
Gamma -> your exposure to the speed of movements in the underlying
You can also think of theta as the compensation/rent for selling/buying gamma.

Different options will have different exposures. Lets take a look at the greeks for the 1 month UVXY vs the 1 year UVXY delta 50 call options. Below is the graph for delta and gamma of the options. You can see that the delta 50 strike is very different across expirations! Which is a counter to your original observation. The 50 delta strike for Sept is $27 and the 50 delta strike for June22 is $75.
View attachment 265601

The reason this is the case is best explained through an example using AAPL. We will look at the extreme - Imagine AAPL had a future volatility of 100% and you were asked to bet on the range of AAPL stock price over the next 10 years... what would your range be? Well AAPL is trading at $145 and we know it cant go below 0. But it could go to 1k or 2k maybe 5k! So we now have a future distribution that looks like the below.
View attachment 265600

Where AAPL could trade anywhere inside that blue range over the next 10 years. Notice there is much more room to the upside but we are bound by 0 on the downside. That is why you will see delta above spot on very volatile stocks or options that have a long duration.

If uvxy were to move up $1. The $75 June22 strike would move up .50 and Sept $27 would also move up .50 all else held equal. BUT what about if UVXY moved up $2? Well we know that both options made .50 when UVXY moved from from $26 to $27. What happens when UVXY moves from $27 to $28? That is where gamma comes in. The delta has now changed. Sept $27 strike is now .55 delta and the LEAP $75 June is still .50. This is because these options are a lot less sensitive to gamma (quick movements in the underlying). This also means they are a lot less sensitive to theta (decay from a change in time).

Instead the leap becomes super sensitive to Vega (change in expected movement).
But here is where it gets really interesting... remember from the picture above we looked at a scenario where AAPL future vol was 100%? What if instead it was 0%? Well the chance of an OTM option expiring ITM are 0% so the delta becomes 0%. This is referred to the change in delta with respect to a change in vega. So you need to keep that in mind when you are trading OTM leaps - your delta exposure could change quickly if vols were to change.

When you are trading the options its important to look at what exposures you have. What are you sensitive too? LEAPS will have extreme sensitivity to Vega and delta and very little sensitivity to theta/gamma. The greeks are very important for every option. After all, its the tool you use to get your desired exposure to the world. So make sure they are inline with your thesis!
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Dam good post, you answered in a way a dummy like me could grasp. Thank you!

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Greeks on LEAPS

TrailerParkTed