Options and Greeks

...and then you woke up LOL.

Are you using a data feed that doesn't have arbitrary symbol limits that renders otion chain scanning pointless? You must have a fairly fat pipe or co-locate at exhange if your universe of stocks is non-trivial.

 

Still awake.

It's done in batch. I don't care in realtime if there's unusual activity, I can scan several thousand stocks after hours in a few minutes to look for trades the next day. Rarely does unusual activity signal an overnight event.

DTN's a pretty nice feed.

 

The four Greeks you are most likely to concerned about as a new options trader are delta, gamma, vega and theta.

They are inter-related but not in the way you describe above.

Delta: At its simplest, delta measures how much an option will move relative to the underlying security. Additionally, delta represents the likelihood an option will settle in the money. Since most options models assume the underlying will follow "random walk" - all at the money options (both calls and puts) will have a delta of .5. In other words, if the underlying is 15.00, both the 15.00 calls and puts will have a .50 delta. If the call is worth .30 and the underlying moves from 15.00 to 15.10, the option will be worth .35 (((15.10 - 15.00) * .5) + .30)). Similarly, the put will be worth .05 less as a result of this move.

At 15.10, the likelihood of the 15.00 call settling in the money increases. Therefore the delta of the 15.00 call will increase. If the delta increases the options will be more sensitive to price movement. For example, if the delta increased to .60 after this move and the stock went up by another 10 cents, the call would be worth .41 (.35 + .06).

The reason you don't always see this relationship hold is because of something called volatility skew. The above example assumes that volatility is the same across the strike series. The 14.00, 14.25, 14.50, 14.75, 15.00, 15.25, 15.50… calls and puts all have the same volatility (say 15%). I don’t know what you are watching, but virtually all futures contracts I am aware of skew volatility. In that case, as a contract is rallying your option may be going down the skew. This means that instead of the 15% volatility you saw when the contract was at 15.00 the volatility may now be at a 14% when the contract moved to 15.10. As a result, even though the contract went higher the call may not have gained any value (it may have even lost value) because of its now lower volatility.

Gamma: Gamma simply measures how much the delta of an option will change relative to a change in the underlying asset price. As you might imagine, skew messes this up as well.

As an aside, because of the skew – very few traders I know use Delta and Gamma. There are other measures (very cleverly) called skew delta and skew gamma that takes the skew into account and doesn’t force you to put an ice pick through your eye when option values don’t do what you expect them to.

Vega: Some people call this Lambda or Kappa as well. What Vega measures is the amount of money an option price changes based on a 1% change in volatility. This is usually expressed as a dollar amount though sometimes it is expressed in points. To give an example: Let’s say you bought 10 15.00 calls. Let’s further assume that volatility is 15%. Since you purchased options you are long volatility or long Vega. In other words, you make money if volatility goes up (assuming no price change in the underlying). If your Vega is $100.00 and volatility increases from 15% to 16% your net liquidity goes up by $100.00. Of course, if volatility decreases from 15% to 14%, you will be $100.00 poorer.

This is the reason guys that sold calls before 9/11 lost money even though the market was crashing. The market dropped hundreds and hundreds of points but volatility went up 30%. So even though their calls were far out of the money, they were worth more than when they sold them. (I am personally a volatility seller – but beware of the adage that all volatility sellers know “eat like a bird – crap like an elephant”).

Theta: Theta measures how much less an option will be worth - holding price and volatility constant. This is also called time decay. As you move closer to the expiration of an option theta will increase and Vega will decrease.

Hope this helps.

By the way, when people tell you to simply look at Black Scholes to figure this stuff out – tell them that, while they are trying to sound superior, they don't know what they are talking about. Black Scholes assumes European exercise. That is why the futures exchanges use CRR, Whiley or binomial models and not BS.

 

That’s not strictly true. The delta (Nd1) is the hedge ratio. Probability to be called (Nd2) gives the actual probability that the option will expire ITM.

Can I assume that was a swipe at me ?

So anyone that uses BS for pricing American options “don't know what they are talking about” ? Hmm, I didn’t realize the value of early exercise was so significant. Thanks for the enlightenment.

 

Actually, there are variations of Black Scholes that adjust for early exercise, so not all is lost for the good old BS.

 

Of course it was a swipe at you. You were being a dick to someone who was simply trying to get information.

Trading options is hard and this is a place new folks come for help. If you don't want to provide it - that is fine. But don't try and make people feel stupid because they don't have your experience.

 

Tower

Pointing someone towards the BS equation when they are asking about "greeks, specifically how greeks effect each other?" is hardly being a "dick". After reading your post above I suggest you'd do well to revisit the equation yourself !

As for helping others, if you care to read a few of my 292 posts you will see that I have done just that many times. I've also been on the receiving end of valuable help and advice from this forum.

This is a good forum. But occasionally it does get spoilt by self-righteous idiots like yourself, calling others "dick" without provocation, whilst no doubt simultaneously playing with it

 

Yes. I agree. At this moment Tower has only 10 posts, and used them all to re-awake old thread by adding (partly) incorrect posts.
And now he's even already starting to insult ppl.
Imagine, 10 posts only and already close to my ignore list.

Ursa..

 

That must be some kind of a record!

 

But this is exactly what makes ET so much fun, a little bit of the old fisticuffs and learning through humiliation and sarcasm and a swift kick up the butt . You've got to love it!
But in all fairness, Tower seems like a nice human being and his info is mostly right - I like him.
daddy's boy