The Greeks. Are they Greek to you?

Hi Mark

Reading thru your blog, I feel I have a lot to learn. I noticed
the graph you use above.  Is there any software you recommend for us?

When I look at Greeks of the positions (I use OptionsXpress), there
are Delta, Pos.Delta, Pos.Gamma, Pos.Theta and Pos.Vega. What is the
difference between Delta and Pos.Delta?

I may know the definition of each
Greek, but I have no idea what the numbers represent.

For instance, -59
for Pos.Delta, -3.12 for Pos.Gamma, 14.66 for Pos.Theta and -7.49 for
Pos.Vega.(I have an IC with some kite) What message do those numbers
tell us?

Thanks

***

Hi 5teve,

You do have a lot to learn.  It' not difficult to understand what an option is.  Options are not complex.  But putting everything together so you can understand what your position is supposed to do to make or lose money requires an education.   I understand that you are a rookie
option trader and I don't know where you are in your education process.
  Take your time.  You have the rest of your life to trade.   

It's important to be able to speak the language of options and to understand the terminology.  However, memorizing definitions without knowing how to translate those definitions into real world terms, does not help you learn what it is you want to know.  Let's see if I can clear up any
difficulties you may have with the Greeks.

First: Choosing software is personal. I have not found anything I like – at least nothing that is available at no cost.  I don't require complex software, and look at the cost-free alternatives.  For my needs, my broker's offering is good enough.

Now on to the important discussion.

***

I'm sure you understand that each option has certain properties.  For example, you know that a call option has positive delta.  In the options world, each of those properties is represented by a Greek letter (ignore the fact that vega is not from the Greek alphabet). 

Collectively those characteristics of an option are knows as 'the Greeks.'

What purpose do those Greeks serve and why should you care?  The Greeks are used to quantify (in terms of dollars gained or lost) the estimated risk and reward that you will realize for a specific option, or group of options, if certain market events occur. Because you must understand how much you can make – and more importantly, how much you can lose – if the stock moves 5 points, or if three weeks pass, or if the implied volatility increases by 4 points, it's necessary to pay attention to the Greeks.  They allow you to make a very good estimate of just how much money is on the line at all times.

Position Delta

That 'group' of options may be a simple spread, such as a calendar spread or an iron condor.

However, the group of options can include more individual options, such as the entire collection of options in your portfolio.  Using different words, those are all the options that comprise your option POSITION.   Thus "Pos. Delta" represents your 'position delta' or the sum of the individual deltas associated with each of the options in your entire position.

Your position delta is calculated by adding the delta of each option you own and subtracting the delta of each option you are short (i.e., sold).  If you own 10 RGTO Dec 80/90 call spreads, your position delta = 10 x the delta of the 80 call, minus 10 x the delta of the 90 call.

**Remember that calls have positive delta and puts have negative delta.  Thus, when you sell puts, you subtract a negative number, and position delta increases.  When you buy puts, position delta decreases.

What's the point of knowing position delta, or any other Greek, such as position gamma or position vega?  As mentioned, the Greeks provide a good estimate of risk (and reward).  In your example, the message to be derived from: position delta = -59 is: 

If the underlying asset moves higher by one point you can anticipate earning that number of dollars.  In this case that is -$59. In other words, a loss.

Instead of getting confused by positive and negative numbers, look at it this way:  If you have positive delta, you are 'long' and should profit when the underlying rises.  When you have negative delta, you are 'short' and should profit when the underlying falls.

Keep in mind:  Each Greek is merely an estimate.  The market does not 'promise' to deliver a $59 profit if the stock declines by one point.  Other Greeks are in play, and sometimes the effects are additive and sometimes they offset each other (more on that in Part II).  

Repeated for clarification:  The Greeks don't do anything.  They don't make money.  They don't make positions risky.  Greeks allow you to measure risk.  the Greeks allow you to measure potential gains and losses.  They serve no other purpose.

When you measure risk, you have a choice.  You may live with the risk, or you may hedge that risk.  That's why the Greeks are essential for risk management.  When you measure a risk factor (delta, time decay, etc,) you can hedge, or reduce, that risk.  You can ignore the risk or offset all or part of that risk. 

When you trade stock, if you believe you are too long and uncomfortable with the risk, all you can do is sell some shares.

When you trade options, there are many reasonable alternatives to get 'less long.'  One choice is to sell positive deltas or by buy negative deltas.  And that does not mean you must buy or sell calls or puts.  You can hedge (adjust) the position (or portfolio) with any combination of options, including a kite spread.  Obviously some choices are more efficient to trade than others, but knowing how to hedge a position is one of those matters you learn from experience or by reading Options for Rookies.

When you understand how position Greeks translate into real money, you are well-placed to make important risk management decisions.  When the definitions of the various terms are merely a blur, you cannot function efficiently.

to be continued

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14 Responses to The Greeks. Are they Greek to you?

  1. 5teve 04/02/2010 at 9:25 AM #

    Hi, Mark
    My understanding:
    1)Pos.Delta = positive = profit when underlying go up; loss when lunderlying go down
    2)Pos.Delta = negative = profit when underlying go down; loss when underlying go up
    3)Delta and Pos.Delta: For instance, 10 contract of Rut Jun 770 call, Delta=0.07, Pos.Delta=73.14,
    I assume 0.07 times 10 contract equal 70, Pos.Delta should be 70, why there is 3.14 difference?
    Thanks,Steve

  2. Mark Wolfinger 04/02/2010 at 10:27 AM #

    5teve,
    You already know the answer to this question.
    Delta = 0.07 is the delta to one significant figure.
    Obviously the delta is 0.07314 to four significant figures.
    Your other ‘understandings’ are correct.
    Best regards,

  3. JB 04/03/2010 at 12:18 PM #

    Hi Mark,
    In the term (as in terminology and not a length of time) “own 10 RGTO Dec 80/90 call spreads” don’t you need to identify which strike is long and which short? You could also identify it this is a credit or debit spread or a bull/bear spread and infer the long and short strikes, but I would opt for the most specific statement. Or, is the first strike always the long side?
    All the best and thanks for sharing your knowledge. This is a GREAT blog! You provide a real service.
    JB

  4. Mark Wolfinger 04/03/2010 at 1:48 PM #

    JB,
    Thank you.
    One of my pet peeves is the usage of unnecessary wording to describe something simple. Thus credit/debit, as well as, bull/bear are superfluous.
    If you OWN a spread, you bought it. If you are short a spread, you sold it.
    By DEFINITION, if you buy a spread – call or put – you are paying a debit. You are buying the more costly option and selling the less expensive.
    Thus, to OWN the RGTO Dec 80/90 call spread already tells you that you are paying a debit for the bullish position: Buy Dec 80 calls and sell Dec 90 calls.
    Similarly, when you buy a put spread, you are paying a debit for a bearish spread in which you own the more expensive put and sell the less expensive put.
    If you SELL a call spread, it automatically means that you are collecting a CREDIT for a BEARISH position in which the sell the more expensive call (lower strike price).
    To me, BUY or SELL is all the description that is needed. Don’t know if I can convince the world, but that’s how I describe options.
    Does that work for you?
    Regards

  5. JB 04/03/2010 at 3:31 PM #

    Hi Mark,
    Yes that makes sense. Just have to remember that to own:
    put = buy higher strike, sell lower strike (same exp. date)
    Call = sell higher strike, buy lower strike
    Thanks.

  6. Mark Wolfinger 04/03/2010 at 4:59 PM #

    Hey JB,
    I didn’t mean to make it complicated.
    I was not giving you anything to remember.
    Why you buy a vertical spread – and these are vertical spreads – the own the more expensive option.
    You should not have to remember that the call with the lower strike is more expensive. You should not have to remember that the put with the higher strike is more expensive.
    Those are the basics of options. A true beginner may have to ‘remember’ those things, but they become second nature almost immediately.
    All you have to know is whether you are buying or selling a specific spread. Too many books confuse matters with those unnecessary adjectives (credit, debit, bull, bear).
    Example:
    The GOOG 570/600 call spread:
    If you buy the spread, you buy the 570 call (and sell the 600).
    If you sell the spread, you sell the 570 call.
    That’s all there is to it.
    I truly hope that helps. I’m trying to make it easier for you.

  7. JV 04/04/2010 at 5:55 PM #

    Hey Mark,
    Trying to find out if you or any of your posters have used a xxxxxxxxxxxxx course. They claim to have an iron condor strategy that is 10 times safer than traditional condors and virtually no drawdown. Keeps talking about some “broken butterfly wing” technique too. It wants $2900 for a “membership” but doesn’t seem to have any money back guarantee. It smells of scam but I can’t find much feedback through thorough googling. Didn’t know if you ever heard of them or whatever they could be touting. Thanks.

  8. Mark Wolfinger 04/04/2010 at 7:13 PM #

    Hi,
    1) There’s a difference between over-charging and a scam.
    2) “Ten times safer” is a meaningless term. Does this mean they lose 1/10 as frequently as ‘traditional’ iron condor traders? Does it mean the average loss is only 1/10 the size? [I don’t see how it can be this choice]
    3. I’ve run across their name on occasion, but know nothing about them.
    4). My inclination is to avoid anyone charging anything remotely near that figure, yet I know a very successful person who charges north of $6,000 and seems to have plenty of business.
    5) The tough question is: Is this price fair for what you are taught? There is no way to know that in advance, and that’s why I vote a big ‘no.’
    6) When you ‘tout’ to people who don’t know the message, your product may be attractive – but the buyer has no idea of what a fair price is.
    7) ‘Ten times safer’ sounds good. Broken wing butterfly spreads have merit, although I don’t use them. But those terms tell you nothing valuable.
    If you sell options with 1 delta as part of an IC, you are certainly more than 10 x safer – if you measure safety as the ‘chance of losing.’ But with the reward so low, it’s not a viable strategy.
    8) If you dare get involved, ask questions: a) define ’10 x safer’; b) give me one example of a trade you made this year – they do have such a video; c) What factors go into deciding whether to adjust a trade or exit for a loss?; d) make up your own.
    9) Big problem: One of their items says “We have developed strategies that are practically risk free, but they still give us the chance to make huge returns each month.”
    Here’s the truth: ‘Chance for huge returns’ and ‘ practically risk-free’ don’t go together. It’s unrealistic. Why not ask them about that sentence in their promotion? Tell them it’s a lie.
    I’ve deleted the name of this group from the question. I know you want opinions, but I don’t want to give them any publicity. It does not appear that they are telling the truth.

  9. JV 04/04/2010 at 7:53 PM #

    Thanks … The fact that they want such a large amount up front and base it all on a “secret method” without explanation brings me much caution.

  10. Mark Wolfinger 04/04/2010 at 8:16 PM #

    If I were inclined to write to them (and I’m not), I would ask: “If your method is so risk-free and prodcues such great results, why would you sell that ‘secret’ for a few measly grand? You could get many millions from any decent-sized hedge fund.”

  11. Aron 04/07/2010 at 10:32 AM #

    JV, I’d ask these people with secret sauce if they’ll take payments for their course from the profits of the trade (say a generous 25%) rather than a upfront $2900?
    If they don’t, you have the answer.

  12. Mark Wolfinger 04/07/2010 at 10:49 AM #

    Aron,
    Nice idea, but unless you agreed to have them manage at least $1,00,000, then would never agree.
    You cannot expect them to take the time on a $50,000 account.
    Regards

  13. JV 04/08/2010 at 10:22 AM #

    Funny … that company I mentioned is following you on Twitter.
    Btw – Do you put your trades on twitter?

  14. Mark Wolfinger 04/08/2010 at 10:52 AM #

    I put some trades on twitter.
    I don’t do all of them because I don’t want it to appear that I am recommending trades. I just share some of what suits my comfort zone.
    And I don’t want to be responsible for keeping track and listing all adjustments. Cannot do that – especially in 140 characters.
    Regards