How to Use Option Greeks to Measure Risk

The Greeks - derived from the Greek alphabet, are used to determine varying degrees of risk attached to the options. If you are dealing in the options market, performing Options Algo Trading, you must be aware of all these Greeks, as they play a crucial role in making any decisions.

To better understand what options Greeks are and how to use them to measure risk, let us have a brief idea of what options are.

Two types of options are there in the market, call and put. The call options give the holder the right to buy certain shares of the underlying stock at a prefixed price and time, known as strike price and expiry time, respectively.

In the same way, the put options give the contract holder the right to sell the shares of the underlying stock at a given time and price.

Greeks are the combination of several terms; all those are used to determine the risk of your options position. The values derived from the Greeks help the trader make a better decision regarding the buying and selling of the options contract.

The Greeks can be categorized into two broad categories, major and minor. The major ones include Delta, Gamma, Theta, Vega and Rho, while the minor ones include Epsilon, Lambda, Vomma, Zomma, etc.

Traders generally consider the values of the major Greeks only as they have more impact on your options trading than the minor Greeks. Let us see how you can measure the risk using different major Greeks.

1. Delta: Delta is the change in the options price due to the change in the underlying asset price. To make it more clear, understand how much the options price will change with every 1 rupee change in the price of the stock. The Delta value can be positive or negative. It is measured between 1 to 0 and 0 to -1.

Note - Call options have a positive Delta ranging from 0 to 1. When your options are at-the-money, it means their delta value is 0.5; as the delta value reaches deep in the money, the value goes near to 1. Put options have negative delta values ranging from -1 to 0. When you say the option is at-the-money, it means it has a delta value of -0.5.

1. Gamma: We have seen that Delta measures the change in the price of options in relation to the stock price change. In the same way, the Gamma checks the rate of change in the Delta value. Gamma tells the traders how much a Delta value should change with the change in the underlying asset's price. We can say Delta is speed, and Gamma is acceleration to control the speed.
2. Theta: Theta measures the time value. The theta Greek's value explains how much the price of an option should reduce with each passing day or when the expiry is near. Theta can be a negative factor for the option buyer, while it's good for the option seller.
3. Vega: Vega represents the volatility in the options market. It shows the price change with respect to volatility in the market. Vega measures the change in the price of the option based on a 1% change in the implied volatility of the underlying asset. The value of the Vega can change regardless of the change in the price because it takes into consideration future volatility. Vega value may reduce when the options are approaching the expiry because, at the time of expiry, the market experiences less volatility.
4. Rho: Rho considers another factor that might impact the options decision: the interest rate. The Rho measures the change in the option price with respect to a 1% change in the interest rate of the underlying asset. It tells the traders how much the price will rise or fall based on the change in the risk-free interest rate.

Investing in options is more complex than investing in stocks or mutual funds. Thus it is very important for any person to measure not only the rewards but also to consider the associated risk. We have seen various Greeks that can help you determine the risk and quantify them in the numeric value. Many Smart Delta Software available in the market can provide you with instant greek values based on a few inputs. If you are using any portfolio management software for Indian stock market or planning to buy one, check if they have the Greek features. Some portfolio softwires have these features some do not have them.

Once you are clear on understanding how Greeks can impact your overall options or portfolio, you will start applying various Greeks to know the risk and reward ratio of the position.

We hope you found the Options Greeks and how to measure the risk using Greeks helpful.

Kalpesh is a experience content writer having vast experience in writing articles of various fields like health, finance, education, textile etc.