What Are Options Greeks?
When investors trade options, there are various dimensions of risk that can be involved. Each of these risk variables is essentially the result of an imperfect assumption or relationship of that option with another underlying variable. Thus, there are a variety of sophisticated hedging strategies that are used in order to decrease or attempt to neutralize the effects of each of these risk variables.
Neutralizing the effect of each of these variables, however, requires a substantial amount of buying and selling. And, as a result of such high transaction costs, many options traders only make sporadic attempts to rebalance their options portfolios.
Therefore, options Greeks are considered to be the essential risk measures and profit / loss guide posts in options strategies. To understand the Greeks, it is important to first note that when taking an option position or when setting up an option strategy, there is going to be risk as well as potential reward from areas such as price change, changes in volatility, and time value.
For an investor who is an option buyer, risk will occur with a wrong way price move, a fall in implied volatility, and from a potential decline in value on the option due to the passage of time. Conversely, a seller of that particular option faces risk with a wrong way price move in the opposite direction or from a rise in implied volatility, but not from time value decay.
When an option strategy is created by an investor, there will be an affiliated Vega, Delta, and Theta position, as well as other position option Greeks. And, when options are either traded outright or are combined, then the option Greeks positions can be calculated so that the investor can be aware of just how much risk and potential reward is encompassed in that particular strategy.
Investors are advised to try and match their outlook on a market to the position Greeks in a strategy so that if their outlook is correct, then the investor will be able to take advantage of favorable changes in the strategy at every level of the Greeks.
In addition, option Greeks can also be incorporated into strategy design at an extremely accurate level using mathematical types of modeling as well as some sophisticated types of software. However, at a more basic level, the options Greeks can be used as a type of guide to show the investor where the risk and the reward can generally be found.
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