The Greeks indicators are something that I have been dwelling for the past few weeks as soon as my buddy asked: “Do you guys look at the greeks when you trade options?”. The obvious answer is no. I may have looked at it, but hell, I have no idea what it was for and how it will affect the options profit calculation. So, as usual, the only way to know is to spend hours learning the nuts and bolts of an option.
There are five Greek symbols related to an option; Delta, Gamma, Vega, Theta, and Row. I am currently trading using the Robinhood platform, and luckily this information is readily available to view before I plan to purchase an option.
Delta – Return based on the movement of the underlying stock
Gamma – move based on the Delta movement
Vega – volatility changes
Theta – price decrease each day
Rho – sensitivity to changes in the risk-free interest rate
To trade an option, the greeks that I find to be relevant are the Delta and Theta. Why?
Using Delta, one can calculate a profit return for each $1 movement of the underlying stock. For example, if an underlying stock delta is 0.20, for every $1 move, the profit return is 100 *0.20 = $20. Theta, on the other hand, is the cost embedded in the premium per day. If the theta is -0.20, for each day, the option loses its value of 100*(-0.20) =($20).
Options that are further out of the money from the stock price will not increase as much per dollar move as they have a more significant component of theta and vega in the options. Options that are in the money will gain more per dollar move as it has a more delta component in the option. While buying options out of the money are far riskier with higher theta, a massive movement of these options will swing the most percentage-wise. Using ratio and risk to reward comparison, it makes sense to find options with Delta to Theta ratio of 1:1 or 2:1.
I am still applying the logic above in my current options trade. Its a learning curve on my end, and hopefully, I am on the right path. Again, options trading is way more technical than investing in stocks or building a dividend income portfolio. I can feel myself turning slowly from value investor to a day trader, buying and selling options daily, and looking at charts to analyze the trends.
I am looking forward to making profitable trades next week! Stay home and keep on learning new things.