March 4, 2009

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.

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