Now, it’s time to learn the Greeks and their super powers! The Greek values can be used to measure risk to find the best trading opportunities. The platform’s Sensitivity trading tool gives indicative Greek values over a range of market rates.
In this lesson, we give you an overview of each Greek. When you are ready, go to the next and final lesson for ‘The Greek calculations’!
Unlike a trade in the underlying market whose value per a point stays the same, the value of an option for every point’s movement in the underlying market is constantly changing. The Delta can be used to measure the value of an option as the market moves. This is useful to monitor directional risk so you know how much your option’s value will increase or diminish as the underlying market moves.
The Delta represents the option’s equivalent position in the underlying market. For example, a EUR/USD Call option with a +50,000 EUR Delta is equivalent to a long (through buying) 50,000 EUR/USD position in the underlying market. Conversely, a EUR/USD Put with a -75,000 EUR Delta is equivalent to a short (through selling) 75,000 EUR/USD position in the underlying market.
The Delta is constantly changing as the underlying market moves. Options further in-the-money (ITM) have a higher Delta. This indicates that ITM options are worth more per pip movement in the underlying market and out-the-money options are worth less per pip.
The table below shows the range of Delta values for a GBP/USD Call option in the amount of 100,000. As the GBP/USD rate rises, the option is moving further in-the-money and the Delta rises. On the other hand, as the market falls, the option moves further out-the-money (OTM) and the Delta falls towards zero.
The Delta is also known as the ‘hedge ratio’, since it gives the amount which must be traded in the underlying market in order to hedge the option.
The Gamma reveals how much the Delta will change if the underlying market moves by 1%. This provides information on how the Delta will change as the market moves. A larger Gamma means the Delta is more sensitive to movements in the underlying market.
In the platform’s Sensitivity table, the Gamma is given as an amount in the traded pair’s base currency.
If you bought a EUR/USD Call option with a Delta EUR 30,000 and a Gamma EUR 20,000 and the underlying market rises by 1%, then your Delta will increase to EUR 50,000 (30,000 + 20,000).
The Gamma is useful when using the underlying market to hedge options, since it gives an idea of how much you need to hedge in the underlying if the market price moves up or down 1%.
The Vega shows the sensitivity of the option to the underlying market’s volatility. You should know from Lesson 4, as implied volatility increases the option’s premium increases.
The Vega amount, given in the second currency of the pair traded, is how much the premium will change for every 1% change in implied volatility.
The Vega for a buy Call trade in the Sensitivity table below, is currently at 75.64 USD. This means if implied volatility is increased by 1%, then the option’s premium will increase by 75.64 USD, and if the implied volatility is decreased by 1%, then the premium will decrease by 75.64 USD.
Note: Volatility is the amount the market price fluctuates without regard to direction. Hence, implied volatility and Vega could increase even if the market is moving against you.
The extrinsic portion of an option’s premium decays each day as the option gets closer to expiry. At expiry, the extrinsic value has completely decayed leaving intrinsic value only. Theta indicates how much the option’s premium will decay each day, i.e., it is a measure of the rate of time decay.
The Sensitivity table below indicates the Greek values of a EUR/USD buy Call option. Theta is currently -43.65 USD meaning, as long as all variables remain the same, a day later the premium will have decreased by 43.65 USD.
When trading a short (sell) strategy, you will see a positive Theta value. This is because an option seller collects Theta each passing day. Time decay is good for an option seller, but bad for an option buyer.
Rho measures the sensitivity of an option to change in interest rate of either the base or secondary currency of the traded pair. This is the least important Greek as options are less sensitive to interest rate changes than to other parameters, however it’s worth mentioning. If the interest rate change is in your favour, then the premium will increase by Rho percent for every 1% increase in interest rate and the vice-versa is true, too. Time is also a factor here as over a longer time more interest is received or paid, hence the Rho is larger.