Have you ever wondered why some individuals are able to trade stock options so confidently and effectively? Besides having the basic knowledge of how the stock market works, identifying the trend direction, possessing the right attitude and knowledge of what are the “Greeks” and understanding how they work, will reduce the risk in trading stock options tremendously. To become a successful stock option trader or investor, we all have to start from the bottom and work our way up by learning the basics of stock options.

I am not referring to ancient history of Greece when i mentioned about the “Greeks”. In stock options, the “Greeks” are actually sensitivities to option risk characteristics. The value or premium of stock options are affected by seven different factors. They are:

1. The type of stock option contract purchased or sold ( Call / Put )

2. The underlying stock or asset price

3. The strike or exercise price of the stock option contract

4. The expiration date of the stock option contract

5. The volatility of the underlying stock or asset

6. The risk free interest rate

7. The dividends payable to stock holders and stock splits

Among these factors, there are four important factors that are the most commonly taken into consideration as they affect the stock option value or premium greatly. They are:

• The speed of the movement of the underlying stock or asset price

• Time decay due to expiration date of the stock option contract

• The volatility of the stock or underlying asset

• The risk free interest rate

Each factor can be represented by a “Greek” word to reflect the sensitivity of the stock option.

Here’s the relationship between the “Greek” word and the factor.

Speed of underlying stock or asset price movement > Delta Δ

Time decay due to expiration date of the stock option contract > Theta Θ

The volatility of the stock or underlying asset > Vega Κ

The risk free interest rate > Rho Ρ

Besides these “Greek” words mentioned above, there is Gamma Γ, and Zeta Ζ. Gamma Γ represents the change of the stock option Delta Δ relative to the change of the underlying stock or asset price. While Zeta Ζ represents the percentage change in the stock option price per one percent change in implied volatility. Among these two “Greek” words, the Gamma Γ is more important as it affects how fast the Delta Δ changes, and it should be taken into consideration together with the four “Greek” words mentioned above when analyzing the probability for the stock option to make a profit.

When making decisions to make a trade or investment with stock options, the “Greeks” of the stock options certainly play a big role in making forecast on the probability of the trade or investment to make either a profit or loss. By understanding these “Greek” words for stock options, the odds of winning are to your advantage, and the decision of making a trade or investment will be done with confidence as it is backed by the knowledge because the individual will be making trade or investment decisions based on calculated risks as compared to someone who makes risky decisions without understanding how the “Greeks” for stock options work. Besides, there are stock option strategies that can be used or combined when one understands the use of the “Greeks”.

*Prior to reading this article, it is advisable and expected that the reader already has some basic knowledge on stock options.

Written by: Ben Ang