When trading options you will need to consider price, time, and volatility at the same time. That means understanding the interplay of a few options greeks and how they play off one another.
Here’s what we know. Options aren’t stocks. And you can’t just track profit and loss (P&L) in a vacuum based on what the underlying stock is doing—making it tough to figure out your exit strategy. For that, you’ve got to consider stock price, time, and volatility (vol), which are measured individually by the options “greeks”—delta, theta, and vega. Knowing how each greek works alone is one thing. You should also know how they play off one another during the life of your trade. Master this, and you’re well on your way to mastering the art of the exit.
Let’s examine the greeks with a holistic approach. We’ll consider two different trades—a long call and a long call spread—from the time each trade is placed, to three days later, and then at the end of one week. We’ll also look at what can theoretically happen to those trades if the stock moves up or down $5, or if the price is unchanged.
On the day of the trade, suppose the underlying stock is at $125, and both trades expire in 30 days. Out of the gate, the trades have the following greeks:
LONG 125 CALL | LONG 120–129 CALL SPREAD |
Price $4.50 | Price $4.50 |
Delta +50 | Delta +30 |
Gamma +3 | Gamma 0 |
Theta -8 | Theta -1 |
Vega +14 | Vega +1 |
Three Days Later
To view your trade profile and the impact of greeks, go to the Analyze tab on thinkorswim from TD Ameritrade, add a symbol, and select Risk Profile to get started.
Seven Days Later
$120 (stock down $5) | $125 (unchanged) | $130 (stock up $5) | |
Trade Date +3 | Delta and theta contribute to losses; gamma helps slow the losses from the delta. Net result is a loss of $234. | No movement over three days, so theta results in a loss of $27. | The trade profits from delta and gamma, while theta plays the role of spoiler. The net result is +$268. |
Trade Date +7 | Delta and theta contribute to losses as the trade loses $265, another $31 since trade date +3. | After seven days and no stock movement, the loss is $63, which is an additional loss of $36 since trade date +3. | Delta and gamma drive profits but are tempered by the additional losses from theta. The net result is a profit of $237, $31 less since trade date +3. |
Three Days Later
Bear in mind, there can be multiple forces to consider when calculating or predicting the P&L of an option. Visualizing the greeks working together helps.
$120 (stock down $5) | $125 (unchanged) | $130 (stock up $5) | |
Trade Date +3 | A smaller delta leads to smaller losses; gamma is still not involved, and theta hurts trades minimally. There’s a net loss of $150. | With a positive theta of around $1 per day, the trade profits $3. | Profits from delta; gamma has no real impact; and theta can claim it helped out some. The net result is +$153. |
Trade Date +7 | Smaller delta and negative theta lead to a loss of $161, $11 more since trade date +3. | With a positive theta of around $1 per day, the trade profits $6, compared to $3 at trade date +3. | Delta and theta drive profits; short gamma is negligible. Net profit of $168, which is $15 more since trade date +3. |