Will tell you a secret that 90% of traders do not know. Fundamental traders on the other hand will know these and use them to take the alpha (abnormal profit) out of the market in option trading.
Options trading is about understanding the Greeks, specifically Delta, Gamma, Theta and IV, although IV is not Greek.
Once you understand this, you can understand how to build your strategies, and why many of the strategies below will practically fail.
Delta is the change in premium (the premium is referred to as the price of the options) for any change in the underlying (the underlying is referred to as the stock). Which will give you an indication of the sensitivity of the premium to the underlying.
Gamma, which is the change of premium for the change in delta, will give you an idea to buy or sell.
Basically a higher gamma indicates that the delta changes more with a change in the underlying, which means that the premium changes more because the delta is turning higher and thereby the gamma is also rising.
Thus, without high momentum, you can find high premiums in your shares. This will prompt you to stay away from buying the option.
You really should have bought the option when the 2 was going down. Thus it gives you the timing of the position/strategy you want to take.
Theta is a measure of the time decay effect on your premium. The less time is left for expiration, the less (or even negative) theta is obtained.
There are options out of the money / in the money the typical behavior is negative theta.
This means that these option premiums will decrease rapidly as they remain in/out of the money and as time goes on. But as the option becomes at the money, theta generally behaves positively.
Knowing these will help you execute your strategies. There is another factor that will require more understanding – implied volatility (IV).
IV basically a measure of the sentiments around the market. If there is a bullish sentiment, the IV call will be higher than the put.
If one day the underlying rises sharply, there will usually be a lot of put buying, and the IV in the put will be higher.
So the IV is a measure of feelings of the underlying direction of the future, not the present. It is also a measure of a stock’s momentum and volatility.
Use them, study their changes and how you can come up with your own option strategies to make the best use of these Greeks.
With practice, your hit rate and ROI of strategies will improve immensely.
But nothing comes easy strategies need to be implemented well and the only way to do it is to understand the Greeks.
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