Greeks in option trading refer to a variety of risk measures used to quantify the amount of risk associated with the price of an option. The most common greeks include delta, gamma, theta, vega and rho.
Delta is a measure of an option’s sensitivity to changes in the price of the underlying asset. It is the rate of change of an option’s price with respect to the change in price of the underlying asset. In other words, delta measures how much an option’s price will move when the underlying stock moves by $1. Options generally have a delta between 0 and 1 for calls and -1 to 0 for puts.
Gamma is the second derivative of an option’s price with respect to the underlying asset’s price. It measures the rate of change of an option’s delta with respect to the change in the underlying asset’s price. In other words, gamma measures the rate of change of an option’s delta when the underlying stock moves by $1. Gamma can be positive or negative, depending on the direction of the delta. Positive gamma shows that an option’s delta will increase when the underlying stock moves higher. Meanwhile, negative gamma indicates that an option’s delta will decrease when the underlying stock moves higher.
Theta is the rate of decrease in an option’s price as time passes. It measures the rate of decay of an option’s value with the passing of time. In other words, theta measures the time decay of an option’s value. As time passes, the intrinsic value of an option decreases, resulting in lower option prices. Theta can be negative or positive, depending on the type of option. Generally, calls have negative theta and puts have positive theta.
Vega is the sensitivity of an option’s price to changes in the volatility of an underlying asset. It is a measure of an option’s price movements with respect to changes in volatility. In other words, vega measures how much an option’s price will move when the volatility of the underlying asset changes. Vega can be positive or negative, depending on the type of option. Generally, calls have positive vega and puts have negative vega.
Rho is the sensitivity of an option’s price to changes in the interest rate. It measures the rate of change of an option’s price with respect to the changes in the interest rate. In other words, rho measures how much an option’s price will move when the interest rate changes. Rho can be positive or negative, depending on the type of option. Generally, calls have positive rho and puts have negative rho.