GREEKS: SENSITIVITY OF OPTION PRICES TO DIFFERENT VARIABLES

 

Market practitioners use Greek letters to denote the sensitivity of option prices to changes in variables.

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For investors holding a single option position its sensitivities are mostly of secondary importance.

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For a dealer managing a large number of positions, Greeks are useful descriptive portfolio indicators.

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Option portfolios may house a large number of positions, each with different strikes and expiration, making it difficult to precisely predict the movements of the portfolio. Calculating the aggregate sensitivities of the portfolio facilitates its valuation and risk management.

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Dealers also hedge their positions by taking off-setting positions in other options and in the underlying.

The sensitivities of the resulting portfolios are dynamic, so they change constantly as time passes and as the result of market moves.

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We describe Option Price Sensitivities to the following variables:

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VEGA: Changes in Option Prices due to Changes in Volatility

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DELTA: Changes in Option Prices due to Changes in the Underlying

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GAMMA: Changes in Delta due to Changes in the Underlying

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THETA: Changes in Option Prices due to changes in Time