Why Greeks Matter with Options
We all know that options offer great leverage, as well as flexibility.
They offer us the ability to make money if the price of the underlying instrument moves up, down, sideways, or not at all. Let’s say I wanted to buy 100 shares of NVIDIA Corporation (NVDA) in early January 2018.
At the time, the stock traded at $223.
To buy 100 shares, it’d cost me $22,300. Not many of us have that kind of money just sitting around. So, we can opt to pick up an option contract, which allow us to control 100 shares without ever taking ownership of those shares.
Let’s say I chose to buy the NVDA February 16, 2018 225 calls with a current price of $10 (or, $1,000 per contract). If NVDA gains $5 a share, I make 2% on $22,300 risked. That’s not much at all. However, with that same $5 move in the underlying stock, I had an opportunity to make 24% on $1,000 risked on the calls.
He came to that conclusion by relying on Options Greeks, which help me figure out how much money I can make based on set criteria characterized by five Greek symbols. For example –
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- Delta tells us how much an option will change every time our stock moves up $1. For example, with the NVDA February 16, 2018 225 calls, I can see that for every $1 move higher in the underlying NVDA stock, I earn $0.4852 at the time.
- Gamma tells us how much the delta can increase every time the stock moves higher. For every $1 move higher in the NVDA stock, gamma tells us how much more the delta will increase by. For example, if NVDA moves to $224, delta will increase in value by 0.0193. It may not seem like much, but it adds up.
- Theta is time decay. It will tell us how much our option price loses every day. For every day you hold an option it will lose value. That’s just how it is. Nothing in life is without risk. Theta tells us that our call option will lose just over three cents at the moment. This will speed up and get bigger as you near expiration.
- Vega tells us how much an option price will change on moves in volatility.
- Rho tells us how much options will change with interest rates. No one really pays much attention to rho any more. The rate of change here doesn't move much.
In a nutshell, that’s how we can calculate potential rewards. And as you can see with our NVDA examples, the rewards can be quite bigger than if we just buy the stock itself.
It proves yet again that options have many advantages over the use of stocks.
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