You have already seen that the value of options contracts keeps changing due to the changes happening in one or more than one of the several variables namely the stock price, time to expiry, volatility and risk-free interest rate, etc. The relationship between the option premium and these variables is explained using a Greek letter as a short form. Delta of an option (symbol Δ), for example, explains the rate of change of option price in relation to the price of the underlying share.

Option Greeks measure the sensitivity of option prices to the various other factors affecting the option.

Five Greeks.

Delta (Δ) – It is the rate of change in the premium of the option contract whenever there is a change in the price of the underlying stock. It is assumed that other factors do not change.

Gamma (Γ) – It is the rate of change in the Delta for one whenever there is a change in the price of the underlying stock. It is assumed that other factors do not change.

Vega (ν) – It is the rate of change in the premium of option when compared to the volatility of the underlying stock.

Theta (θ) – It is the rate of change in the premium of option whenever there is a change in the time to expiry.

Rho (ρ) – It is the rate of change in the premium of option whenever there is a change in risk-free interest rate.

Why Greeks are important

The effect of change in the premium of option with the change in each variable is important information for investors who use options for hedging risk. If the Delta of an option, for example, is 0.50, it means that whenever the price of the underlying stock changes by Re 1, the price of the option changes by 50 percent. This information is useful in various conditions. An in–the–money option with a higher Delta, for example, would give a higher profit when compared to an in-the-money option having a lower Delta.

How are they computed?

Calculation of Option Greeks is done using the Black Scholes formula. Unless one is academically interested in maths, deriving option Greeks may not be practical. Although it is not important to know the computation of Greeks, it is a necessity to be aware of how these are applied. These values can be calculated easily using various online tools.

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