Stock Options: Understanding the Greeks

Option price fluctuations can be frustrating for new traders, especially when they don't move in tandem with stock prices. The theoretical values that help us to quantify an options risk characteristics and therefore its price movement are referred to as the Greeks. The Greeks most often refereed to in option trading are Delta, Theta and Vega. We will cover each in the following article and try to give an easier understanding of how to use these important numbers.

Delta is probably the most commonly used Greek, in fact many new option traders only use this one. A simple definition for Delta is the change in the option price relative to a change in the underlying asset. Delta will be close to positive or negative 50% when an option is at-the-money, but an important point to remember is that it is constantly changing as an equity price fluctuates. The deeper in-the-money an option becomes, the higher the Delta, because the price is composed of more Intrinsic Value. As an option moves OTM the Delta gets smaller. The changes happen for mathematical reasons, but to make it easier to understand think of the Delta from what you would do as an option seller. If you buy a KO $55 Nov 2007 call today for $.80 with the stock trading at $51.25 your Delta is about 28%. Meaning if the stock were to move $1.00, you would only capture 28 cents of that move. This makes since from an option sellers standpoint. They sold you the stock 2 strikes OTM, exposed themselves to unlimited risk and collected only a small $80.00 premium per contract. If the option moved in value in tandem with the stock, no one would ever sell OTM options. So the reasons behind Delta can actually be thought of from a pure reasoning perspective.