I thought I would share this here, although it's not specific to trading options, it is hopefully an interesting musing for you all.... The formula for human happiness is quite simple, and the greeks have had it all long. No, not the “Ancient Greeks” of Socrates and Plato, rather the more modern, “Option Greeks” Anyone who is an option trader knows the Black-Scholes model, and its key derivative measures: Delta, Gamma, Theta, Rho and Vega Just as each of those derivatives directly affects the price of an option, so too they phenomenally mirror our own human behavior in a fascinating way Delta – Change Delta is the simplest Greek, and determines how much an option price changes by a change to its underlying. If the underlying stock goes up, so does the value of the option (for simplicity, let’s stick to Call options here). In human nature, the simplest form of happiness comes from good things happening in your life. The magnitude of those goods things directly affects your level of happiness. You find a penny on the ground and you might smile, while when you reconnect with an old friend you might laugh. On the day you get married, you might cry laughing of happiness, because the delta, the change at that moment in time is so positive. The opposite is true, as of course negative delta can do the exact same Gamma – Rate of Change Gamma is a second order derivative and measures the rate of change in delta. It’s the acceleration to delta’s velocity, the higher the gamma, the faster delta increases. When good things happen to us, our happiness is magnified when they happen quickly together. Sometimes your whole day just goes right. You catch the bus you though you were going to miss, your boss recognizes you for a job well done, your YOLO OTM TSLA calls go deep ITM after hours. If one of those things happened individually, it would great, but when all of them happen close together, generating many positive changes in the “delta” of your happiness, the effect is magnified. Unfortunately it of course works in reverse any many a time some of us have felt “what else can go wrong today?” Stubbing your toe might not be a big deal, but it could be the last straw after a terrible day where you got fired and your wife left you. Vega – Anticipation of Change The measure of “implied volatility” or the likelihood of a change in the underlying is called vega, and explains why options for fast moving stocks are priced higher than those for blue chips that barely change in price The same can be said for the anticipation of events. When you are waiting for the big game to start, you are excited and happy. You can’t be sure that your team will win, and in fact if it loses that would be a change in delta and probably upset you, but the very fact that an important event is coming up that can have a high delta change is inherently making you happy. Even when you are preparing for a bad outcome, the anticipation of that outcome not happening still gives you hope and happiness. Of course the bigger the expected change in the delta of your happiness, the more excited you feel. It’s one thing to wait for a football game to start, and a whole another level when you are excitedly clutching an engagement ring you are about to propose with Theta – Time As an option nears expiration, its value decreases as there are simply less possibilities that option becomes valuable again, in what is know as “Time” or “Theta Decay”. If you’ve achieved a certain level of happiness delta, and you stay at that level long enough, you will start to get unhappy. Sadly, human nature is such that complacency breeds angst. We need to have continually increasing delta of happiness in our lives, we live on always measuring our progress against the past, and striving to be better, make more money, have more love and so on. If we don’t continue on this upwards trajectory, our happiness decreases. In many cases, it manifests itself as the “Midlife Crisis”. Ostensibly, many men (and women) that go through it should be happy. They have a nice life, a good house, a happy family, a solid job. They worked hard after college moving up to that level and building their dream life, but eventually hit a ceiling or just lost a bit of that ambition that used to drive them. Then, several years into it, they look back and feel like they should have done more, or that they’re missing out on something, and their happiness level decreases solely by function of time, and not by any actual change in delta. Rho – The Happiness of those Around Us In finance, Rho is a unique derivative as it does not relate to the option or the underlying itself, but rather to the market as a whole, as it measures the sensitivity to the risk free rate of return. In general terms terms, the higher that risk free rate, the higher the price of the option. This is one of the common failings of our human happiness, in that it often depends on how we are doing relative to others around us. A person growing up surrounded by poverty and crime in a war torn country is thankful just to have the basic opportunities that others take for granted. The base level of happiness for him is so low, that he may not need large delta changes to be happy, just seeing the sunrise every day and surviving is enough. On the other spectrum, many of us blessed to have grown up wealthy, surrounded by everything needed, can never seem to find happiness no matter how hard we try. How many times do people that seem to have everything fall into depression or even take their own life. Oftentimes its simply because they are so used to having so much “Rho” around them that their own amazing life and even success seems trivial, irrelevant and unsatisfying. The fascinating parallel between two seemingly unrelated concepts, option pricing and human happiness, is in the end unsurprising. Human behavior drives both our social life and economic patterns, such that the two are inherently interwoven.
You may have taken your analogies too far. You have taken a complex human problem and used a complex model of finance to improve understanding. A dismal area of intellectual thought, at that. The genius is in simplification. That is why religious stories and parables have lasted so long. There's almost 200,000 years of work in these. Now, lower the muzzle which is pointed at your head and disengage the hammer.
While the concept is coool, I don’t really agree with those analogies. and btw, the entire financial world is built off and predicated off humanness. just look at the words we use for terms in finance. bonds.. a lender and a borrower “bonding” credit... the act of acquiring loans based off past actions “give him credit” options... give you many different “options” to speculate trust... bequeath inheritance.. “I trust you with my wealth” the terms bullish and bearish, in the way the animal swings at a target (up or down) mortgage - signing a death pledge lol interest etc etc it goes on and on.. the world of finance is more metaphysical and esoteric than we think
Yeah it's quite weird. Someone just made it up to sound greek and I don't know why they didn't pick an actual greek letter since there's plenty of others. This is the story I heard about it and not sure if it's true or not: "The story about its origin that I find most believable is the following. Soon after the publication of the Black-Scholes formula, smart entrepreneurs grabbed the opportunity to produce and sell computational software, first for the function value produced by the formula itself, but soon also for its derivatives. One of the basic lessons of marketing is that when you want to sell something, you have to give it an attractive name. Therefore, it may have been a marketeer for a software vendor who invented the term “vega”, for use in sales talk: “Is your current software capable of computing vega, Sir? Our product can do it.” It would take a rather self-assured manager to admit that he does not even know what vega is."
I think it used to be more popular to refer to vol as kappa, which is a greek, but those cavemen may have moved on by now.