Option Greeks are some of the components that make up options trading. Options give you the right but not the obligation to buy or sell a stock at an agreed upon price. Each options contract controls 100 shares.
As a result, it's cheaper to place an options trade than buying 100 shares of a stock outright. However, options are riskier because of other factors like option Greeks that affect the profit and loss of a stock.
Although the capital needed to place a trade isn't as much, your ability to lose the entire trade is much higher. As a result, this article delves into using option Greeks to your advantage.
When you're trading stocks vs options, stocks are pretty cut and dry. You open a position. When you've reached your profit potential, you close it. There's no time limit on it so you can hold forever if needed in order to correct a bad trade.
When it comes to options, it's pretty different. All options expire. It's up to you to choose how long you want to hold your contracts as well as where you want to buy. The great thing about options is the fact that they don't cost as much as stocks.
As a result, you can trade the large cap stocks and control a good amount of shares without putting up a lot of money. It's a great way to grow your brokerage account.
Many seasoned traders rely on option Greeks to evaluate whether or not they should make the trade. However, many new traders aren't aware of the option Greeks and how to use them. There are some traders who are aware but don't know how to implement the option Greeks in their trades.
What are option Greeks? Per Investopedia they're statistical values that measure the risk involved in an options contract in relation to certain underlying variables. There are four Greeks that we'll discuss.
Our options trading course goes in depth into the Greeks and how to trade them.
Delta makes up part of the Greeks. It's the most popular of the Greeks because it's the easiest to understand. It measures the rate of change in price. In other words, Delta tells us how much an option would increase when the stock moves up a point.
It'll be positive for call options and negative for put options. Depending on your strategy, you can use Delta to determine the probability of the contract being in the money at expiration.
Many times, you want to be in the money at expiration because the more in the money you are, the higher the your profit potential is. Many times when you go to place and options trade, you want a higher delta.
The higher the delta the higher the risk and reward. While there is high risk, you can offset that by practicing proper risk management and trading patterns. You want traction so where you buy your option determines how well your contract moves.
Remember that the higher the delta the more expensive the option will be. The reason is because you have a higher probability of expiring in the money. Hence a higher profit potential. In the money gives you more of a cushion too.
Vega makes up another of the option Greeks. This options Greek maps out the sensitivity of volatility. It doesn't matter if you're trading stocks or options, volatility will always be important.
Vega measures the rate of change in implied volatility. Implied volatility is the expected volatility of an option. In other words, Vega shows you how much an option's price will change for every 1% implied volatility moves.
You can use Vega to see how different strategies would work when they look the same based off the Delta. Hence option Greeks go hand in hand. You can't really have one without the other.
Gamma is the most ambiguous of the option Greeks. In essence it measures sensitivity to Delta. Delta increases and decreases with price movement so Gamma stays constant to measure that change.
The higher the Gamma the more risky the trade. The lower the Gamma the less risky. The risk you want to incur is up to you. Many times the riskier the trade, when payed right, is a lot more rewarding.
A higher Gamma means more volatility. That's something you have to be able to stomach. Especially for longer term options trades. Which means direction matters.
Hence playing candlesticks, patterns and trends will help immensely. Check out our services to learn more about trading options.
Theta deals with time decay. Options are wasting assets because they expire. Time is constantly moves forward. As a result, your options decay. Think of it like an hourglass.
The more time passes, the seller of the option profits. So the seller would be the bottom of the hourglass whereas the buyer would be at the top. As a result, profit drips to the seller on a daily basis.
80% of options expire worthless. That means many times, the seller is the winner.
Option Greeks should be used together to determine the risk of a trade. The amount of risk you want to take on is all about your strategy. There's no right or wrong strategy. However, not using the tools provided to you hurts you.
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