Understanding the “Greeks”
To understand the movement of option price, we need to understand the “Greeks”. Option price movement is affected by its underlying (e.g. stock) price, time decay, volatility, and interest rate.
Delta
The speed of option price moving relative to the underlying stock position.
- Deep ITM = Delta near 1
- Deep ATM = Delta near 0
- Higher Delta means higher change it will end at ITM. That’s why Deep ITM has Delta near 1, highest change it will end at ITM.
Gamma
Measures the speed of Delta moving. Deep OTM and Deep ITM options have near zero Gamma, and ATM has near one Gamma. Option ATM has the fastest pace of Delta. Near ATM (Delta near 1), the option price is very sensitive to stock price changes.
Theta
Measures option sensitivity to time decay. Long option has negative Theta, because time decay will decrease option value. Remember option value = intrinsic value + time value. The opposite goes to option writer.
Vega
Measures option sensitivity to volatility. Long option has positive Theta. Higher volatility will help long position, because option price is also affected by volatility.
Rho
Measures option sensitivity to interest rate. Positive Rho means that higher interest rate will help position.
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