Sudhir Raikar, Mumbai | February 17, 2017 16:52 IST

In the context of financial tragedies,

Trust the Greeks for providing a reliable compass to find our way through the often-turbulent, living waters of premium movements – in the form of a lighthouse popularly known as ‘The Option Greeks’. A better appreciation of the Option Greeks will help novice traders lock horns with the intricacies of Options pricing, which go far beyond mere price movements of the underlying stocks or indices and merit a deeper probe into the distinction between option price and option value.

The Option Greeks find their roots in mathematical models like Black-Scholes and Cox-Ross-Rubinstein. They quarantine a given variable to study the effect of its change on the options price. Consequently, we get a concrete rationale, albeit theoretical, to base our trading decisions which otherwise could prove to be a nightmarish experience if driven by blind faith, half-baked advice or reckless choices. If you develop some resonance for the Option Greeks, you would never say, “It’s all Greek to me”. To help you do just that,

Delta:

I measure the rate of change of option’s premium for every percent change in volatility which is in turn represented by fear and uncertainty over likely and unlikely market developments. All options, whether calls or puts, rise in value with the rise in volatility thereby increasing the likelihood of the option expiring ITM. No marks for guessing that I am a positive number, for both calls and puts. All other things being constant, I will always be higher for ATM options compared to the other two variants given that ATM options are most sensitive to volatility in terms of aggregate points. Need I add that OTM options are the most sensitive to volatility in percent terms.

**Theta: ****All about time and its decay**

I measure the rate at which an option loses value with the passage of time. As options get closer to expiration, the rate of money loss increases, so does the premium. The eroding premium represents the time decay. Simply put, I represent loss of points in the given time frame. I have different mood swings for different strike prices. For deep OTM and ITM options, I deplete at a furious pace in the initial stages and get reduced to almost nil during the concluding phase. But for ATM options, I do the contrary, constant during the initial periods and super-fast in decay during the last phase, with the pace of deterioration maximum in the last leg. I am the hot favourite of option sellers for obvious reasons. By the way, time expiry is more crucial than what you think. So even if my friend Vega shows high volatility, he may have a limited impact on the option value if the time to expiry is less. So, read mine and Vega’s values in concurrence given that time and volatility are interrelated variables.

**Rho: ***Strictly a matter of interest*

I begin (and end) with a humble submission! Yes, I don’t matter much to you given the relatively steady state of bank interest rates. Yet, no harm in knowing me better. I stand for the change in option value for every percent-point change in interest rates. My formula is rather complex, but it should suffice to say that I am calculated as the first derivative of the option's value with respect to the risk-free rate. Interest rates are used in pricing models to consider the options price based on its hedged value. I am positive for calls bought, as higher interest rates push call premiums up. Conversely, I am negative for puts bought as higher interest rates erode put premiums.