The “Greeks” in options trading — known as delta, gamma, theta, and vega — are metrics that help traders understand the value and pricing of a given options contract.
Because options are derivatives, the value of each contract — the premium — depends on a complex interaction of different factors, including time to expiration, price volatility, and changes in the value of the underlying security. Each of these factors is represented by a Greek letter.
While there are a number of options Greeks to explore, delta, gamma, theta, and vega are the four main Greeks in options trading.
Options Greeks may sound like a foreign language, but to options traders the Greeks are essential to understanding how, or if, they’re making any money, since it can be so difficult to understand the true value of an option.
A Quick Look at Options
“Options” is short for “options contracts,” which are a type of investment that traders buy and sell much like stocks and bonds. But options are derivatives — that is, they aren’t really assets in and of themselves. Instead, their value (or lack thereof) derives from another underlying asset, typically a specific stock.
Traders buy different types of options, when they think that stock prices will go up (a call) or down (a put). They also use options to hedge or offset investment risks on other assets in their portfolio.
Recommended: How to Trade Options: A Beginner’s Guide
In a nutshell, though, traders typically buy options through an investment broker. Those options give investors the option, but not the obligation, to buy or sell a security at a later date, and at a specific price. Investors can buy an option for a price, called a premium, and then buy or sell that option.
So, while an option itself is a derivative of another investment, it can gain or lose value, too. For example, if an investor were to buy a call option on Stock A — basically, a bet that Stock A’s share price will increase — the value of that call option would go up if Stock A’s price goes up.
But the opposite would be true if an investor purchased a put option on Stock A, betting that Stock A’s price would go down. Similar to shorting a stock, the investor would effectively lose their bet (and see the value of their option fall) if Stock A’s share price increased.
💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.
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What Are Option Greeks?
Options traders use these letters to describe their option positions and make their best guess as to what might happen next with those positions as they relate to the underlying stocks.
In short, the Greeks look at different factors that could impact the price of an option. Calculating the Greeks isn’t an exact science. Traders use a variety of formulas, usually by a mathematical model. Because of that, these measurements are usually all theoretical.
Here’s a look at the most common Greeks used by traders.
Recommended: Options Trading Terms You Need to Know
Delta measures how much an option’s price will change if the underlying stock’s price changes. Specifically, it measures the option’s price change in relation to every $1 change in the underlying stock. It’s usually expressed as a decimal, like “0.50,” for example.
So, if an option has a delta of 0.50, in theory, that means that the option’s price will move $0.50 for every $1 move in the stock’s price. Another way to think of delta is that it gives an investor an idea as to the probability that they’ll make money from an option. If delta is 0.50, for example, that can equate to a 50% chance or so that an option will expire in the money — that an investor’s bet will have paid off.
The second Greek, gamma, tracks the sensitivity of an option’s delta. If delta measures how an option’s price changes in relation to a stock’s price, then gamma measures how delta itself changes in relation to a change in the stock’s price.
Think of an option as a car going down the highway. The car’s speed would be its delta. The car’s acceleration would be its gamma, as acceleration is measuring the change in speed. Gamma is also typically expressed as a decimal. If we go back to our earlier example — that delta is 0.50 — and delta changes to 0.6, then gamma would be 0.1.
Theta measures an option’s sensitivity to time. It gives investors a sense of how much an option’s price decreases the closer it gets to expiration.
Similar to the “car on a highway” analogy, it may be useful to think of an option as an ice cube sitting on a countertop. The ice cube melts away — or, the option’s time value diminishes — and the melting becomes more rapid over time.
Theta is typically expressed as a negative dollar amount, and represents how much value an option loses each day as it approaches expiration.
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Markets are volatile, and securities (and their derivatives) are subject to that volatility. Vega attempts to measure how much an option’s price will change as it relates to the underlying security’s volatility.
Volatility refers to the turbulence a security’s value experiences. We don’t know what level of volatility a security or option will experience in the future, however, so there’s a certain amount baked into the mix — that’s implied volatility. It’s the expected future level of volatility.
Changes in stock volatility can change an option’s value. That’s what vega is measuring — not volatility itself, but the option’s sensitivity to volatility changes.
And like delta and gamma, vega is expressed as a number, rather than a dollar figure.
5 Main Options Greeks: Overview
In summary, here’s how an investor may use this data when analyzing the risk and reward of an options contract.
|How investors might think about it
|Measures the sensitivity of an option’s price to a change in the price of the underlying security.
|For example, if the delta is 0.50 means that the option’s price will move $0.50 for every $1 move in the stock’s price.
It can also indicate a 50% chance or so that an option will expire in the money right now. This probability may change over time and isn’t a guarantee.
|Measures the rate of change for delta. It tells you how quickly delta will change as the stock price changes.
|Think of an option as a car on the highway with its speed (delta) and acceleration (gamma, often expressed as a decimal). A stock trading at $10 with a delta of 0.4 and gamma of 0.10 means that a $1.00 increase in the stock’s price will adjust the delta by 0.10, increasing it to 0.50 and vice versa with a $1 decrease it will decrease delta to 0.3 impacting how quickly the value of the option will increase or decrease with further price movements.
|Measures the sensitivity of an option’s price to the passage of time.
|An option’s theta is like an ice cube melting on a countertop – the time value diminishes as it melts and the melting becomes more rapid over time. This is expressed as a negative dollar amount. For example, a theta of -1 indicates that the option will lose $1 per day until it reaches the expiration date.
|The change in an option’s value as implied volatility goes up or down by 1 percent.
|Vega rises with greater price swings (higher implied volatility), indicating higher uncertainty. Lower implied volatility implies lower uncertainty and smaller price movements.
|Measures the sensitivity of an option’s price to a change in interest rates.
|If an option has a rho of 1.0, a 1% increase in interest rates leads to a 1% increase in value. Options most sensitive to interest rate changes are those at-the-money or with the longest time to expiration.
Other Options Terminology to Know
The specific options (a call versus a put, for example) and the underlying stock’s performance determines whether an investor comes out ahead on their bet. That brings us to a few other key options terms that are important to know:
In the Money
A call option is “in the money” when the strike price is below the market price. A put option is “in the money” when the strike price is above the market price.
Out of the Money
A call option is “out of the money” when the strike price is above the market price. A put option is “out of the money” when the strike price is below the market price.
At the Money
The option’s strike price is the same as the stock’s price.
There’s no getting around it: Options, and the Greeks, can get complicated, and may not be the best investment strategy for beginners. But experienced traders, or those willing to spend time to learn how to understand options, find them a valuable tool in creating an investment strategy.
Qualified investors who are ready to try their hand at options trading, despite the risks involved, might consider checking out SoFi’s options trading platform. The platform’s user-friendly design allows investors to trade through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors.
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