The Greeks Flashcards
What are the Greeks?
Set of risk measures indicating an options sensitivity to movements in underlying price, value decay implied volatility changes and changes in interest rate. The Greeks help you understand risk exposures. Being great neutral produces the risk exposure from some factors. BS model can be used to calculate Greeks. Theta, Delta, Gamma Rho, Vega.
Delta hedging. what is it? Why is it used? How does it work?
Delta hedging or being Delta neutral involves holding shares of a stock and selling calls to maintain a risk free position, minimising risk to potential movement in stock prices and still make a profit. The number of shares held per option sold is the Delta. Showing this in a question you would first find delta ratio then the value of the hedge portfolio, and then the portfolio value intermediate times step such as t=1 and then their return on the hedge. This should equal the risk free interest rate given.
When does Delta change in the life of an option?. And what is the relationship between underlying asset and the value of a call? When does Delta approach one and when does it approach 0?
Delta changes throughout the entire life of an option and therefore as the underlying stock price increases the value of a call increases. Delta approaches one if the option is deep in the money and close to the expiration date. Delta approach zero if the option is deep out of the money and close to the expiration date. Delta of an underlying is one.
What is theta representative of?
Theta measures the decrease in value of an option due to passing of time also known as decay.
Change in option price/Change in time.
How is gamma different from Delta? When does gamma have the highest and lowest value?
Gamma is used for estimating changes in option premium more accurately for larger stock price changes. Gamma also measures the sensitivity of Delta relative to the changes of the underlying price. Gamma is at its highest when the option is at the money meaning it is the most sensitive and hardest to hedge when X=So. Is also the highest when it’s the closest to the expiration date however it will drop to 0 once the option has expired.
What is Vega representative of and when does it have the highest value?
Vega measure the sensitivity of an option Price to implied volatility, change in option price/change in implied volatility. Vegas has the highest value when the option is at the money. It is the most important Greek as it feeds into the option pricing model as implied volatility because expected future volatility of the underlying is unknown.
What is Vega representative of and when does it have the highest value?
Vegan measure the sensitivity of an option Preiss to implied volatility, change in option price/change in implied volatility. Vegas has the highest value when the option is at the money. It is the most important Greek as it feeds into the option pricing model as implied volatility because expected future volatility of the underlying is unknown.
What is Rho?
Rho measures the risk of exposure to a change in the risk free rate. Change an option price/change in risk free rate. The formula only works for small changes in the risk free rate.
