January 17, 2020

How the Greeks Work Together (Or Don’t)

We are looking at a theoretical example in Micron (MU).  Let’s assume that MU will report earnings next week after the market closes.  Even though Implied Volatility is currently extremely expensive, it most certainly will move higher as we approach earnings.

So, a thought process might be, why not buy volatility now if it’s going to move higher by next week? We first must understand what changes an option price as volatility moves. That “Greek” is known as Vega.  Vega measures the change in the value of an option with a 1% change in Implied Volatility.

For example, if the Implied Volatility of the MU February expiration, 42 strike call is 74.29, which can be seen below, and its VEGA component is 2.62, then the value of this option will change by $.0262 when the implied volatility changes by 1%.

So if the implied volatility rises by 6 points to 80.29, then the value of the option will rise by $.1572,  (6 x $.0262). Conversely, if the implied volatility decreases by 10 points to 64.29, then the value of the option will decrease by $.262, (-10 x $.0262).

Again, if we believe that implied volatility is going to rise by next week, we should buy it now, right?  Not so fast. This is where one of those other “GREEK’s” comes into play. Theta measures the amount of premium or time decay that decreases the price of an option daily.  The THETA of this option is $0.11, which means that this option will lose $0.11 daily due to time decay. One additional characteristic of THETA is that it is not linear, meaning that an option does not decay the same amount each day.  It actually increases by a greater amount the closer to expiration it becomes. But, for example purposes, let’s say that the February, 42 strike call did decrease by $0.11/day due to theta.  Then looking ahead the earnings report we would experience decay or a decrease in the value of this option by $.88, (8 x $.11).

As you can clearly see, the price decrease due to theta decay can far outweigh the projected rise in implied volatility that we expect to see leading up to earnings.

 

about the author:

Scott Bauer

A respected market commentator seen on Bloomberg, Fox Business, CNBC and other major financial networks, Scott Bauer has 25 plus years of professional equity and index options experience at the Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange (CME) and as a Vice-President/trader for Goldman Sachs. Scott graduated with Honors from the University of Illinois Business School and has taught classes both at his alma mater and at the CBOE.

Read Similar Articles

May 8, 2024

What Is Delta In Options Trading?

Understanding the Delta of an option is crucial for both new and seasoned traders. It’s one of five specific calculations called “Greeks,” which help measure specific factors that could influence the price of an options contract. Delta is a metric that helps you gauge how much the value of an option contract is expected to […]

Read Article
March 28, 2024

Wait! There Is An Options Greek Called Rho?

Out of all the Greeks in options trading, Rho is capable of providing uniquely critical insights that others cannot offer. Rho measures an option contract’s susceptibility to changing interest rates. We’ll explain how Rho by defining its specific functions, how interest rates impact options trading, and cover some pertinent scenarios. What is Rho in Options […]

Read Article
March 25, 2024

You Have A Lot Of Options Out There

There are a number of different types of options expiration types.  In the vast majority of our signals, our options will be categorized as “American”-style options.  There are some, like VIX options, that are “European”-style options.  Here’s a quick explanation of both. The term “American style” in relation to options has nothing to do with […]

Read Article

Read Similar Articles

May 8, 2024

What Is Delta In Options Trading?

Understanding the Delta of an option is crucial for both new and seasoned traders. It’s one of five specific calculations called “Greeks,” which help measure specific factors that could influence the price of an options contract. Delta is a metric that helps you gauge how much the value of an option contract is expected to […]

Read Article
March 28, 2024

Wait! There Is An Options Greek Called Rho?

Out of all the Greeks in options trading, Rho is capable of providing uniquely critical insights that others cannot offer. Rho measures an option contract’s susceptibility to changing interest rates. We’ll explain how Rho by defining its specific functions, how interest rates impact options trading, and cover some pertinent scenarios. What is Rho in Options […]

Read Article
March 25, 2024

You Have A Lot Of Options Out There

There are a number of different types of options expiration types.  In the vast majority of our signals, our options will be categorized as “American”-style options.  There are some, like VIX options, that are “European”-style options.  Here’s a quick explanation of both. The term “American style” in relation to options has nothing to do with […]

Read Article