What are Options Greeks?

Last Updated: 5 Dec 2023

Generally, new investors tend to put their money in stocks as they are one of the most sought-after and straightforward asset classes. However, experienced investors, who already have a large sum of money invested in stocks, scout other asset classes to increase their profits. One such asset class is Derivatives.

What are derivatives?

A derivative is an instrument that derives its value from the underlying asset. The asset can be equity, a commodity, currency, or even an index. Derivatives are usually in the form of a contract, where the buyer is obligated to buy, or the seller is obligated to sell the underlying asset at a specified price on a specified date in the future. Derivatives have traditionally been used by businesses to hedge against different types of risks for decades. With well-planned strategies based on a thorough study of the markets, individual investors and traders can earn handsome returns through derivatives trading.

There are two types of derivatives through which investors can trade within the market: Futures Contracts and Options contracts. This blog details the process of options trading and how investors use options greeks to analyze an options contract and predict its future price.

What are options contracts?

Options, or options contracts, are essentially a type of agreement between two parties, whereby the buyer has the option but not the obligation to buy or sell an underlying asset. The asset must be bought or sold – depending on the type of options contract– on a specific date and at a predetermined asset price.

For example, if you purchased a call option for 100 shares of XYZ stock at ₹110 per share with an expiry date of 3 months, you’d be entitled to purchase 100 shares of that stock at ₹110 per share regardless of whether or not the stock price has changed till the expiry date. You’d then expect XYZ’s price to rise for this long call option. However, if you choose not to exercise the right to buy the shares, you will only forfeit the premium you paid for the option because you are not expected to buy any shares.

To understand how options trading works and what Option Greeks are, you must be familiar with the type of options derivatives. Here are the two major types of options contracts:

• Call Option: This is a type of options contract that gives the holder the right but not the obligation to buy the asset at the agreed-upon price before the expiration date. The investor can buy the call option by paying a premium upfront to the seller. Therefore, the option holder makes a profit if the value of the asset rises in the future. The call option allows him to buy the asset at a much lower price and then sell it in the market for its current higher price.
• Put Option: A put option is a type of options contract that gives the holder the right but not the obligation to sell the asset at the agreed-upon price any time before the expiration date. If the value of the asset falls in the future, the call option gives him the choice to sell the asset at the agreed-upon higher price, thereby minimizing his risks.

What are Options greeks?

Option Greeks are financial measures based on mathematical formulas to calculate the sensitivity of the price of options contracts against factors such as the price of the underlying asset or market volatility.For example, if you have bought an options contract and want to know if you should exercise the right, you can use Option Greeks to predict if the price will rise or fall. Five options greeks collectively make the term, are:

• Delta
• Gamma
• Vega
• Theta
• Rho

An options trader uses these options greeks to achieve the following objectives:

Option Greeks	Objectives
Delta	Price of the underlying asset
Gamma	Price of the underlying asset
Vega	Volatility
Theta	Time to maturity
Rho	Interest Rate

Types of Option Greeks: What do they offer to options investors?
It is paramount to master the Option Greeks, including 5 components: Delta, Gamma, Vega, Theta, and Rho, to study the change in the underlying value of options price. Consequently, this practice based on theoretical valuations helps build a concrete rationale to make informed trading decisions that otherwise could prove to be a nightmarish experience if driven by blind faith, half-baked advice, or reckless choices.

Options Greeks: Delta: Delta Option Greeks measure the change in the option price for a unit change in the underlying asset’s price. For example, if a Delta of the Call Options contract is 0.5, it shows that for each unit increase/decrease in the underlying asset, the option price will increase/decrease by 0.5 points.

Options Greeks: Gamma: This Option greek measures the change in Delta concerning per unit change in the underlying asset. If the Gamma value is 0.08, it shows that Delta will change by 0.08 points if underlying assets change by 1 point. So Gamma shows what will be the next change in Delta concerning the change in the underlying asset.

Options Greeks: Vega: This Option greek measures the change in options price per unit change in volatility. Vega is directly related to the option price, i.e. higher the volatility (implied volatility), the higher the option price, and vice-versa. For example, a Vega value of 5 shows that option price will increase by 5 points for every unit increase in volatility. Thus, Vega shows the effect of volatility on the option price.

Options Greeks: Theta: Theta Options Greeks measure the rate at which the option loses its time value as the expiration date draws near. It is the rate of decline in the option price due to the passage of time. If theta is -3 and everything else is constant, the option value for the particular day will erode by 3 points.

Options Greeks: Rho: Rho Option Greeks measure the change in options price with a unit change in interest rate. If the Rho of put options is -3, it signifies that for each unit increase in interest rate, the put option price will decrease by 3.

Importance of Option Greeks

For investors who want to trade in options contracts, understanding option market greeks is vital for a successful trading transaction. It is because of the following benefits:

• Option greeks help in mitigating the risk of losses as you can predict the nature of price sensitivity.
• They help in managing your investments as you can understand the effect of volatility on the options contract.
• Option greeks help you take calculated risks and aim towards increased profitability.
• They ensure that your portfolio health stays positive with lower capital depreciation.
• Option greeks help you understand the factors that can affect your investments and ensure that you invest cautiously and in good contracts.

Role of option greeks

Option greeks play an important role for an options trader because of the following factors:

• Option Greeks are investor-friendly financial tools to manage the risks associated with options trading.
• The 5 elements of option greeks allow investors to hedge against the price volatility and ensure they remain profitable until the expiry date.
• The techniques of Option Greeks play a vital role in allowing investors to complete the sensitivity analysis process.
• Option Greeks allow investors to manage the interest rates related to their investments and ensure they are on the right path with their purchases.
• Investors who make decisions based on the outcomes of options greeks know their options contract is going to expire in or out of money.

Option Greek’s trading strategies can prove to be highly beneficial if you are looking to trade in options and diversify your portfolio. You can trade in futures and options through IIFL Demat Account. IIFL Research team can help with customized derivative strategies for your trading and hedging goals. Visit IIFL’s website or download the IIFL Market app from the app store to begin your trading journey.

Frequently Asked Questions

How do Option Greeks help in the stock market?

Option Greeks help the investors who trade in Options to ensure that their investments are safe and bring them profitability. They are based on mathematical formulas that have acute chances of failure and benefit options traders in mitigating losses.

What are the benefits of option greeks?

Options traders can predict future prices, volatility and perform sensitivity analysis based on the five elements of option greeks. It can allow them to mitigate their losses and increase profitability.