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.
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