Options traders have to have a good understanding of an options premium, how it moves, and what are the factors which affect the options premium.

The movement of option premiums decide the profits or losses which the traders can incur. Option Greeks are a very important factor which decide the movement of an options premium. There are several factors which affect the options premium, which are, the underlying stock price movement, Time to maturity, and Volatility of the underlying stock, to name a few. The understanding of an options premium’s sensitivity to Greeks is very helpful and it can improve trading performance in options.

The concept of option Greeks originates from a theoretical model that is the Black Scholes model. According to the black Scholes model, there are 5 important Greeks.

Option Greeks basically measure the movement of the option premium with 1-unit change in the factors affecting them.

Let’s understand the Greeks one by one for a better clarity.

First is the Delta.

Delta measures the options premium’s sensitivity with the change in the underlying stock price or spot price. With a 1-unit change in the underlying price, how much the option premium is going to change (with other factors remaining constant) is basically measured by the delta. For example, if the spot price rises by Rs. 10, how much will the call premium rise, and how much will the put premium fall, is measured by delta. The Delta of Put options is always negative and the delta of call options is always positive.

Next is Theta.

It measures an options premium’s sensitivity to time. It basically measures the decay in options premiums with the passage of time and gives us a rupee value of decay per day. Time is always forward-moving, and options premiums decay with passage of time (with other things remaining constant), hence the value of theta is always negative. Normally, it has been seen that the theta values are very high as the options contract approaches expiry. That means that premiums lose out on value fast, as expiry approaches, and towards the beginning of the contract the theta values are low, meaning, that with each passing day, the decay in premiums is less.

Next is the Vega.

This Greek, measures an options premium’s sensitivity to a change in implied volatility. If there is a 1-unit change in the expected volatility, how much will the options premium change, keeping other things constant, is measured by the Vega. There will be an increase in the value of an options premium, both in calls and puts, with the rise in implied volatility.

Next is Gamma.

The Gamma measures the sensitivity of delta to a change in the value of the underlying asset. In simple terms, if I have to explain, I would say that if the spot price changes, then the options premium changes, which is measured by delta, but as spot price changes, the delta also changes, so now with 1 unit change in the spot price, how much the delta will change, is measured by the gamma, assuming other things remain constant.

Lastly, we have the Rho.

It measures an options’ sensitivity to a change in interest rates. Therefore, any increase in the interest rate may lead to a fall in the value of the options contract since it will increase the cost of carrying the position.

Trading in options requires learning and expertise. An options trader should be well-learned with every aspect of option trading, including different options Greeks that we just discussed in this video.