“That’s all Greek to me”. The phrase keeps popping up every time we come across something difficult to comprehend or understand. “Option Greeks” have the warning “inbuilt”—they are difficult, difficult to compute and take more than a calculator.
But if we understand the meaning, there is a lot of money to earn from understanding these Greeks.
Option Greeks define the interrelationship between factors that affect options premium. If we know them better, we will know the premium movement better, which will help us make the most of our options trade.
We will concentrate on two interrelationships of options premium. One, with the price of the underlying stock or the index and the other, with time.
What is Delta and how it works?
We all want to make money from the price movement but to not lose a lot from unfavourable price movement, we buy options. We know that with the rise in the price of underlying, Call Premium rises. Delta is the Options Greek that tells us by how much.
Delta tells us how much the option premium will rise if the price of the underlying rises. So, the Delta value of 0.5 for 1,000 Call with underlying @1,000 means that if the stock goes up to 1,010, which is up Rs 10, the Call premium will go up by Rs 5 (10 X 0.5).
This Delta is also not constant for an option if the underlying is @1000, 1,000 Call will have 0.5 Delta. But if the stock were to go down to 950, Delta would slip to let us say 0.4. At the same time, at 1,050, the Delta of 1,000 Call would go up and could be around 0.6.
This is favourable because the option is moving much faster with the favourable move but moving slower with unfavourable move.
Making Delta work for you
Looking at Delta one can better judge how profitable a favourable move can be. As each Strike Call and Put Option will have its own Delta, this understanding will give us a logical reason behind selecting the best Strike that justifies the money allocated for buying premium for desired returns.
While this is still about the move that happens in the next few minutes and hours, we must not forget that time also has an impact on the option premium.
With time, the premium of an option reduces. While we know this interrelationship also, our next Option Greek will help us quantify this.
What is Theta and how it works?
This Option Greek is pretty straightforward. Suppose 1,000 Call with underlying @980 is trading at a premium of Rs 10. Its Theta is 1. What this means is that if the underlying stays at 980 and nothing else changes but a day goes by, the, the next day, the same Call of 1000 Strike will have a premium of Rs 9 (down Rs 1).
Use of Theta
Theta, like Delta, too, is not constant—it changes with price of the underlying and the passage of time.
If we are to hold on to the option for a few days, our option premium will go down. Knowing an approximate amount by which the premium will go down with time will help us in setting a time stop-loss.
If the underlying does not hit our target or our stop-loss, we know that after the passage of certain days, we will trigger the time stop-loss. That number of certain days can be estimated with the help of the Theta value of the option by multiplying it and checking the impact of each additional day.
For example, if the stock remained at 980 after five days, my option will be Rs 5, losing half of its value. Now, if I am targeting my Rs 10 premium to double with favourable price movement, I will have to keep a 5-day stop-loss to justify that I would make 2 times what I could lose.
Both Delta and Theta are easily available in option analytics applications. Now that we know what they mean, I would recommend that you observe the actual payout by following the premium of an option for a few days and note down the Delta and Theta and their impact.
I am sure it will help in getting much more out of the options trade now that we know some Greek now.
Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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