An Introduction to Options Trading

Chapter 8

OPTION GREEKS IN PRACTICE

When trading options it is very important to understand the option Greeks, since this helps traders to understand the risk they are facing. Although the option Greeks primarily help traders to understand their risk, it also helps them to determine which strategies will benefit most from their view on a certain company or their view on the overall economy. The following sections will explain the option Greeks in more detail and will give a flavour for which strategies are most appropriate to benefit from certain company or economical events.

8.1 INTERACTION BETWEEN GAMMA AND VEGA

As mentioned in Section 6.3, gamma is large for options with a short time to maturity and vega is large for options with a long time to maturity. However, for both gamma and vega it is the case that they are largest for options close to ‘at the money’. In summary, at-the-money options with a long time to maturity have large vegas and relatively small gammas, and at-the-money options with a short time to maturity have large gammas and relatively small vegas. So, when a trader wants to decide whether he should buy a long-dated or a short-dated option, he is basically deciding whether he wants to do a vega or a gamma trade.

 

In Chapter 7 it was shown that when buying an option the profit for the trader comes from movements in the underlying share, so that he is able to adjust his delta. Every time the trader adjusts his delta, he is basically buying the underlying ...