If you find options Greeks confusing, you are not alone. When I speak to other option traders about technical analysis, I quickly learn that many shy away from the Greeks.
While there are complicated calculations involved in creating a “Greek” value, it is rather easy to interpret the probability of achieving a certain price point within a certain time frame. We won’t get into any crazy calculations in this blog post. Instead, we’ll talk about the best analysis tools starting with my favorite, delta, and its “brother and sister”, gamma and charm.
Delta is the most important options Greek
By definition, the delta is a change in the option value with a $1 move in the price of the stock. It calculates the sensitivity of the option price vs the underlying stock price to tell you the expected move of the option. Note it is not a guaranteed move, as time is constantly eroding the option’s value (theta).
Here’s how I use delta to guide my trading:
A Netflix October 1200 call is worth $50 and has a delta of .50. If the stock moves up $1 then we expect the option to move up to $50.50. That doesn’t seem like much, does it? And you are right – it is just a 1% move in the option.
Meanwhile Intel is currently sitting at $23. An October 24 call with a delta of .35 is selling for $1.25. So that means a $1 move up in the stock would see the option move up to 1.60 (1.25 +.35), which is a much better percentage move (28%) than the stock (about 4.3%).
In short, delta helps you analyze the leverage of a trade.
How to use gamma with delta
Knowing the delta is great, but understanding the second derivatives of delta is just as more important.
Gamma measures the rate of change of an option’s delta for every $1 change in the underlying stock price. It tells us how quickly the option price will move.
If delta is considered the pace of an option, then gamma is the acceleration. Gamma is influenced by time to expiration, strike price and moneyness. Long call or put options have positive gamma, which is what you want if your trade is based on direction. Positive gamma benefits from large moves in the price of the stock.
Meet the little-followed Greek called charm
Charm, or delta decay, measures the rate at which the delta of an option changes over time (it is a derivative of theta – more on that in another article). Institutional traders and market makers use this tool to hedge out risk.
If there is a three-day weekend coming up, I might price in more delta decay on the day markets are closed. This helps me create a “delta neutral” portfolio for hedging purposes.
I encourage you to start using the Greeks to analyze trades. They are really helpful once you get to know them.
