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Options Trading - Introduction to the Options Greeks


Options trading is considered by many traders (both new traders and experienced traders alike) to be extremely complicated and is therefore often avoided (possibly to the detriment of the trader's profit / loss). While options trading is more complicated than many other forms of trading (e.g. forex trading, etc.), options trading is relatively straightforward as long as the basics of options trading are learned correctly, and one such options trading basic is knowing how to use some of the options greeks.

The options greeks (often just known as the greeks) are a series of formulae and values that represent various relationships between options (and warrants) markets and their underlying markets or financial instrucments. The options greeks are so called because they are identified by greek alphabetical letters (e.g. delta or Δ). The options greeks are used by options traders in a variety of different ways depending upon the exact type of options trading that is being performed, but the options greeks are often associated with risk management. The options greeks are therefore sometimes known as the risk measures or hedging parameters of options markets.

Sensitivity Information

The options greeks provide a variety of information about the sensitivity of options markets with regard to price changes in their underlying markets. In other words, how closely an option will track (i.e. move in relation to) its underlying market, and how much the option's price will change as the underlying market's price changes.

It is a common misconception among new options traders that options track their underlying markets directly (i.e. a one point price change in an underlying market corresponds to a one point price change in its options markets). Options do track their underlying markets, but not directly, and the level of tracking can vary significantly over the life of an option (or warrant).

Many of the options greeks (including delta which is discussed below) change their value and their relationship to their underlying financial market over time, so how an options greek will change over time could need to be considered when choosing an options market depending upon the trade that is being made (e.g. the options greek delta determines how closely an options market follows its underlying market, and as the options greek delta changes over time, the relationship between the options market and the underlying market will also change over time).

How the Options Greeks are Used in Options Trading

The most commonly used options greeks are the first order derivatives delta (Δ), theta (Θ), vega (v, but not actually a greek alphabetical letter), and rho (ρ), and the second order derivative gamma (Γ). These are the options greeks that provide the sensitivity information that is most often used by options traders, and traders who trade options as a way of trading their underlying markets (e.g. trading a stock index via its options or warrants markets).

An example of one of the most useful options greeks is delta (Δ). Delta (Δ) represents the rate of change of an options market's price in relation to its underlying market's price. In other words, delta (Δ) indicates how closely an option will track its underlying market, and how much the option's price will change in relation to the underlying market's price.

For example, a delta (Δ) of 0.75 indicates that an option will track its underlying market at a rate of 75%, so that every one point of price movement in the underlying market would be reflected by 0.75 points of price movement in the option.

Delta (Δ) therefore provides useful information in determing which options contracts should be traded for a specific type of trade, and how many options contracts should be traded, in order to directly track a specific underlying market.

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