Archive for the 'The Greeks' Category
Over this last couple of posts I’ve attempted to provide you with an overview on a couple of the Greeks, indispensable indicators in showing you how to trade options “by the numbers”.
I will today wrap up our introduction to the Greeks by discussing Vega and Ro and with regards the former, we”ll return and take another look at the IWM index.
Of the variables which affect the price of an option Vega is certainly one of the most important and is without doubt the most powerful of the Greeks. Vega measures how much an option will change in value because of a one point change in volatility. You may well see a significant change in your position because of a change in volatility.
Back to the IWM. Several days have now elapsed since we last looked at Delta, Gamma and Theta. As at today these are reading at 39.38, -20.03 and 5.15. Do take a look back at the last two posts should you require an explanation of these readings. In this post our focus will be on Vega. Vega shows up as 23.33. So, this is telling us that for every $1 change in increase in the Vega, (or volatility of the market) we will gain an additional $23.33 in profit. 23.33 is a relatively neutral figure which is what we want to see.
We can observe the measure of volatility in the market by tracking the $VIX index. This reflects the measurement of the number of puts being purchased on the CBOE (Chicago Board Options Exchange). As a general rule of thumb, when volatility goes up stocks go down and conversely when volatility goes down then stocks go up. Volatility is a reflection of fear in the market .. when we see more people buying puts that is because they fear that prices will decline .. the more puts purchased, the greater the increases in the levels of volatility. If we compare the graph of the $VIX with that for the IWM (or indeed any of the other indexes) we will see that volatility runs in exactly the opposite direction of market activity. When the $VIX drops back .. the market is seen to be going up and when it goes up, the market moves down.
The IWM positions I have on – a double calendar spread, are short positions – where I am selling in the front month and protecting myself with the calls and puts purchased in the following month. The Vega positions I have on mean that as long as the market continues to rise I will make money and if it drops back I will lose money.
Just a very quick word on Ro. This is not an “active” Greek like the others, but is simply the measurement of the change in value of an option relative to a one point change in interest rates. Interest is used as a comparative because when you purchase an option you are spending money which might otherwise be sitting in an account earning interest.
With a little less volatility in the market things are settling a bit and “touch wood” I will not have to make any further adjustments. As at today, on the spreads I have on – current profit is $752.50 for the month, on a margin of $3,800. If I should be able to hold this position, maximum potential profit is $1,640.44, although sensibly I will be closing off most of the positions over this next 4-5 days. Strange things have been known to happen during the week leading up to expiry!
Even if this current figure of $752.50 was to remain unchanged (and yes, it could go down) that is a 30.47% return on margin .. not for a year .. but for a month! Gotta be better than leaving you money in a bank account getting a paltry 5% a year don’t you think?
Do remember that here we are learning how to trade options as a business and that means managing by the numbers. And, to whom do we turn to get the numbers .. yep, you guessed it .. the Greeks!
A couple of posts back I pointed out how critical it was that if we are to learn how to trade options profitably, then we must “manage by the numbers” and trade as a business. I also introduced you to the Greeks, which I went on to explain are the numbers you need to know in order to manage your portfolio of trades profitably.
Delta you may recall measures the change which occurs in an option’s value and Gamma measures the change of an option’s Delta.
Today we move on to explore another of the Greeks, Theta and in my next post we will wrap up the Greeks with a look at all important Vega and also touch briefly on Ro.
I have just set up new positions for the month of April, and so I will explain these in the light of two of these new positions I have on the IWM index.
As time approaches expiration, the option you have acquired is losing value on a daily basis. Theta is a measurement of that loss in value. The types of positions which we will be looking to put on with the Trading Pro (previously OptionSphere) program are all Theta positive positions. With an option losing value more quickly as it approaches expiration we see this reflected as an increase in the size of Theta. The nearer we get to expiration the greater the increase in size of Theta.
So .. back to the IWM position which I put on a couple of days back. This shows a Delta of -1.49 and a Gamma of -7.11 (both pretty neutral positions) and a Theta of 4.46. So, provided the price remains within a certain range this means that I should be collecting on average $4.46 for every single day I am holding this position through to expiration. The reality is though that price is usually constantly changing and so Theta and the other variables will change along with it. The higher we find Theta then the better it is for us, because that is how we make money when we are trading options.
Now, it goes without saying that you don’t want to find yourself in the position where you have negative Theta. For example, if the above was -$4.46 then this is the amount of money on average I would be losing each day and this loss would become even greater the closer I got to the strike price of the option I’m buying.
Now, in the case of the IWM position I had put on two positions using a double calendar spread. I had purchased a 45 call and a 39 put in the the month of May with the sale of the same in the front month of April. So, in making my selection, to ensure that I did not find myself in a loss situation I had to be absolutely correct with regards both timing and direction. Now, as I say .. almost certainly the price is going to bounce around a bit and I may well find myself having to adjust my positions. But that is no big deal .. and after all .. it’s all part of the art and science of knowing how to trade options with confidence.
When learning how to trade options, it is vital we understand that in order to trade profitably we must “manage by the numbers”; just as we would in any bricks and mortar business. You may have got the impression that trading options is just about placing spreads as opposed to individual trades; partly right, but there has to be a bit more to trading than that. And .. that does not mean that we have to go big on technical analysis using our charts and graphs.
Enter The Greeks! In a nutshell the Greeks are the numbers that you need to know in order to manage your portfolio of trades profitably. So let’s delve a little deeper. The Greeks which concern us are Delta, Vega, Theta and Gamma . In explaining these I will use as examples one of the paper trades which I have on for the month of March.
Fortunately, on the Think or Swim platform, I am able to set up The Greeks so that I have them showing in my Monitor Screen layout and at a glimpse I can see how things are shaping up.
Delta .. is the measurement of change which occurs in an option’s value. With regards the positions I have on in the EEM index, Delta reads at -23.32. In other words I am ‘short’ approximately 23 Delta. Now think of these 23 Delta as being 23 shares of stock which are short. In other words, 23 shares of stock which I have sold but don’t actually own, but which I have ‘borrowed’. In order to make a profit I want my shares to go down. If the price of the shares should go up, then for every $1 rise in the share price , I would lose approximately $23. If the shares should go down by a dollar, then conversely I stand to profit by approximately $23. Think of Delta in this light. Given the other Greeks which I will now turn to .. this is a relatively neutral Delta and is in fact not such a bad position to be in.
Gamma .. is the measurement of change of an option’s Delta, resulting from a 1 point move in the underlying stock. It is not a variable directly of the price of the option; it is a measurement of the change of the Delta. On the EEM, Gamma is -29.37. In other words I am short Gamma. The particular spread I have on is the Sale of an Iron Condor – involving the sale of a 24 call protected by a 26 call and the sale of an 18 put protected by a 16 put. So I’m short both calls and puts and therefore the last thing I want is for the market to move too much on me. We shall see.
In my next post I shall continue on examining both Theta and Vega which you will need to understand if you are to know how to trade options with confidence and I will also provide you with a brief explanation of another one of the Greeks .. Ro. You will also be given a look-in on my present trading activity, which has had its ups and downs this last few days. Fortunately, right now .. things are not looking too bad.