Question

Explain Delta, Theta and Vega in detail, give examples of each on in real life options contracts of an American based stock(this question requires research). After showing your example explain what the changes in the stock price would do to the greeks in your specific case and why?

Answer 1

Delta, Theta and Vega are the Greeks that are used to minimize the risk in options. Greeks are theoretical mathematical formula.

Delta- It measures the sensitivity of price of an option with respect to change in price of underlying stock. It is a ratio that tells the relationship between percentage change in option premium and each dollar change in price of an underlying. It tells how much option's value will rise or fall if underlying stock rises or falls by $1. Delta changes with the stock price. Delta is also called hedge ratio. Some factors that affect delta are; time to expiration, underlying and volatility.

Example: If you buy a Call option with strike price of $30 and spot price increases to $31 then option premium will also increase, if option premium increases by $.30 then option delta will be 30% that is called a "Positive delta" and it will be denoted as "30 Delta".

Delta of a Call option is "Positive" and delta of a Put option is "Negative"

Theta- It is a measure of the time in options and tells the loss of time value each day, as the time passes, options lose their values and premium keeps on decreasing with the passage of time. If theta of an option is -.2, it indicates that option is lossing value of $.20 each day. Declining value of option is the opportunity for options writers as they want the option to become zero so as to retain the premium. It considers the assumption; "everything remains same".

Theta is usually in negative as time to expiration is shorter then lower the value of the option.

Vega- It is also called Tau. It measures the change in option premium if volatility changes. It is always in positive number. Volatility affects the Time value of option. Vega actually measures how much price of an option will change if there is 1% change in implied volatility. If the volatility goes up, the price of an option goes up.

The Call and Put have the same Vega. Vega is maximum near the exercise price.