Option Greeks

Option Trading with the “Greeks”

A very popular method of managing options trades, particularly complex ones, is to use the Greeks…

The “Greeks” that we use are Delta, Gamma, Theta and Vega.

  • Delta tells us the rate of change and the profit and loss of our position for the next point move in our underlying. It gives us a number that tells us what that change will be.
  • Gamma tells us how much the Delta will change after one point and can also be beneficial in letting us know how fast things may be moving for or against us.
  • Theta, which is popular in the Sheridan Community [theta positive], shows the effect of time in either benefiting or detracting from your option position Profit/Loss.
  • Vega monitors the volatility of our position and the effects that implied volatility changes will have on our position. It also is a number that tells us how much profit or loss our position will have with a one point move in the implied volatility of the options that we are trading.

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There is more to trading and managing options than just using the Greeks. Many times I’ve seen traders who thought they could look at the Greeks alone and manage a position, which often leads to problems.

Using the Greeks

Certainly, we would use the Greeks, but you also would want to have a risk graph to monitor your P&L position and the effects of where you are if the trade goes against you.

This concept is very important to understand because, if for instance, we were going for a 10% profit, you really would not want your position to go against you more than 6-7% before you made an adjustment.

Greeks are Vital

As you can see, the Greeks are vital, because we can use them to tell 1) where we are at in a position and 2) where we are going to be in a position.

Further, the Greeks can also be helpful if you do want to adjust the position. One popular technique is to just cut the Delta of your position.

For instance, if your Delta was -1000, you know that if the underlying went up one point you would lose a thousand dollars, so in this instance, you may want to cut that risk down by buying extra options.

Cut the Loss

This move would cut the loss, perhaps, to where you only lose $250 with the next point, thereby cutting by 75% you risk. This is just one of many possible moves to make in this scenario.

Just remember to incorporate Greeks, P&L and a risk graph into your position management and do not rely on any one component to make all of your trading decisions.

Mark Fenton, Senior Options Mentor

Questions? info@SheridanMentoring.com

For more on Managing by the Greeks, Check out a Free Webinar by Clicking HERE!

Iron Condor or Iron Butterfly, which is better?

Often I am asked as an option-trading mentor, “Which is better, the Iron Condor or the Iron Butterfly?” These are both short Vega trades, meaning that they benefit from volatility lowering, however, the structure is different and the pros and cons of each are different.

The Iron Condor is perhaps the most popular option spread trade. The structure is selling a call vertical and a put vertical out of the money, usually by several strikes. This is what you might call a “strangle”.

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The benefit to this strategy is that it is one short volatility and also it has a wider range for the price to move around, up or down, before you get into any trouble with the trade.

This is a good trade for higher volatility markets and if you feel you need more room for the price to roam.

Which is Better?

The Iron Condor would be better than the more narrow strike Iron Butterfly. The downside of using an Iron Condor is that when it does go against you, it is more difficult to repair and/or you can lose more money because you took in less premium, by selling options that were further from the money.

Overall, though, it does have a good probability of profit greater than that of the Iron Butterfly.

The Iron Butterfly is also a trade that benefits from lowering volatility. It is structured by selling an at-the-money call vertical and an at-the-money put vertical with varying long wing widths.

Risk-To-Reward

The Iron Butterfly has more narrow structures than the Iron Condor, however, it has a better risk-to-reward, because your return can be so much higher on-the-money at risk than with the Iron Condor.

This is because you received more premium selling the at-the-money options. Because it has this greater risk/reward, the Iron Butterfly can be put on in a wider range of markets, both lower volatility and higher volatility.

Volatility

Even though it is short volatility, it still performs well, even in lower volatility markets because of the risk reward.

Of course, both of these trades, require that the price stay inside of a range for the trade to be profitable. The Iron Condor gives you more room and the Iron Butterfly gives you less room for the price to roam. However, overall in most markets, I preferred the Iron Butterfly, because of the increase risk reward.

Questions?

Email Mark Fenton: info@SheridanMentoring.com

Check out Dan’s recent Iron Condor class, CLICK HERE!