Elementary Questions on the Greeks

Don has some questions regarding delta and gamma that are worth posting (edited for brevity, when possible). 

If you understand the principles, then using the Greeks becomes far less frightening. 

The Greeks serve one purpose.  They allow a trader to measure risk.  That's it.  They do no more than that.  If the risk is within your boundaries, you can be comfortable with the trade.  If not, you can easily change any specific risk factor.  That's the beauty of using options.  Risk is readily measured and controlled. You cannot do that with stock, currencies, commodities etc.  Options are special.


Hi Mark,

You often mention the effect of Gamma on front
month trading. Are there strategies that use Gamma advantageously for
the trader? 


Advantageously?  Are you saying that + gamma is advantageous and negative gamma is not?  If you want positive gamma, you must PAY for it.  It is not free. If you want gamma, there are strategies to suit: long options, buy straddles, back spreads etc.

You freely choose iron condors (and others) that benefit from positive time decay.  Negative gamma is part of the package. 

Time decay of options is not linear, and graphs show that the last six weeks prior to
expiry has the most dramatic theta effect. Would you explain the positive
and negatives of this trade and have you ever considered trading IC's
in this time frame? 

1) That is not anywhere close to having the 'most dramatic theta effect.'  Any position with less time is even more dramatic. 

The 'most' dramatic theta effect occurs when your option is exactly ATM, it is one minute prior to the closing bell on the 3rd Friday, and news is pending within the next 10 seconds.

2) The positives and negatives of this trade are exactly the same as ANY OTHER iron condor trade.  More time = higher premium, less theta, and less negative gamma. It's always a compromise.  Choose the combination of pluses and minuses that suit you.  Don't let anyone tell you that there is a 'best' time frame for you.

3) I consider trading iron condors in ANY time frame.  For me, front-month trades almost never survive the first elimination round.

Buying LEAPS and selling calls against them: Let's say that an option
trader believes that a stock will rally in less
than 24 months.

If a trader continued to sell options against LEAPS [MDW: assuming the shorts conveniently expire worthless], by the time the long option approached expiry, that could pay for the call and he/she would still own the Jan 15 calls – an ITM option.

Yes,the stock may go below 15, with the LEAPS losing value – but are there other negatives to this strategy? 

Don, I have discussed the idea of using LEAPS in 'covered call' and collar strategies a bunch of times.

Bottom line: Yes, there's big risk.  A big market move or a big decline in implied volatility demolishes this strategy.  See those, and other, posts for explanations.

PUT: if a trader were bearish on a stock, how would the LEAPS work with
Puts? Buy the ITM Put and sell OTM puts against it? 

That's one method.

A web site I saw recommended selling calls and puts on a stock
you like – at the same time. I get worried about this. Anytime you sell,
you have an OBLIGATION rather than a RIGHT and you never know when a
black swan event will hit an individual stock. But I was thinking that
this may be more acceptable on an index, I'd like to hear your opinion.

Who in his/her right mind would sell a naked call on a stock he/she likes?  I assume you already own, or are willing to buy the stock to make this play.  Don, this is merely covered call writing.  The long stock and short call is a covered call.  The naked put is equivalent to a covered call.

Covered call writing has downside risk.  If you don't like the risk, don't make the play.  If you don't want to be obligated to buy shares at the strike, then don't sell puts.

Indexes tend to be less volatile than individual stocks, so yet, this idea is a bit better when using index options.  You would have to buy something to represent the underlying stock.

A follow up on Gamma. Today F is trading at 13.20 and the
Sep 13 Call has a 57 Delta and 22 Gamma (am I correct that like Delta
you simply remove the decimal to factor in Gamma?)  Meaning (to me) that  Delta of the 13 Call will be 77
if it moves up and 35 if it moves down. Is this right? 

The gamma is per share, so multiply by 100 to get gamma per contract. 

Is this right? To a point.  I thought you would know that gamma is not constant and changes as the stock price changes.  Thus, the call delta changes by more than you anticipate (higher gamma at the end of the move than at the start) when the stock rises and by less when it declines (final gamma declines during stock price slide).  But what you have is a reasonable estimate.

If I move out to Dec, gamma is
less. The
reasoning behind this is: as the front month option moves into the money and it is
near expiration, gamma is more pronounced due to the reduction in
time, is this the correct view? 

Yes.  When there is less time, there is less chance that the option will move OTM or ITM.  Thus, delta moves towards 100 or 0 much more quickly.  For delta to change so rapidly, gamma must be higher. 


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One Response to Elementary Questions on the Greeks

  1. Don 08/04/2010 at 7:58 AM #

    (note:moved from original posting)
    Hi Mark/Jason- thanks for the tip on optionsoracle, looks nice- Mark, thank you for your detailed answers- I do have question about the following-
    As to the Long LEAPS/short call, of course you are right the volatility is a consideration- if one buys the LEAPS with IV near it’s low that would address that as much as possible. IF the stock rallies strongly for the September short call I don’t see it causing a loss. The Delta on the ITM long call is 57 and the short call 32 so at least at the beginning movement favors the ITM Long if it rallies strongly I have the 15 call with the 18 sold against it and the 15 had 2.35 extrinsic (time) value at the time of purchase that would not erode substantially in the 45 days that would be included (pro-rated daily) so if the stock rallied to 19 my 15 call would be worth about 6.35 (4+2.35) while the sold 18 call would be worth -1.40 or so I could close out the trade, roll the short or adjust in some manner- have I overlooked something?