FINANCIAL FOCUS
All Greek To Me
In this installation of Financial Focus, we will discuss the topic of the Greek alphabet named categories in the Options market. As always, we will provide some education and commentary for the inexperienced and/or uninformed.
In our publication When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), we introduce the avenue of options trading in the equities markets. Unlike simply buying or selling short a stock, where there is no time limit for which to make your risk management decision to close the trade, options are highly time sensitive.
In addition to the price and expiration date (when the option expires worthless), there are secondary readings to assist in your choice of which option to select on the chain, known as the “Greeks.” Following are the definitions of the 5 main Greeks to consider…
Alpha – is essentially defined as an investments strategy’s “ability” to beat the market, or performance analysis, also referred to as its edge. A high alpha shows an abnormally positive risk adjusted rate of return, above and beyond a select benchmark. Although there is a sophisticated formula involving expected return based on its beta (that can easily be researched), the investor need only know that alpha above 0 (zero) indicates above expected performance, while less than 0 indicates below expected performance. Strong stocks or funds are those that consistently rate as a high alpha.
Beta – is associated with Risk Assessment, and refers to the measure of volatility related to a benchmark, also used to compare and predict possible returns. A “1” beta reading suggests the investment moves essentially in-line with the market. The further the beta is from the 1 standard, the riskier the investment. For example, an equity with a beta level range of 2 reflects twice the volatility of the benchmark, while any reading under 1 suggests less volatility. Growth stocks and leveraged ETF’s will typically have a higher beta, as they tend to perform better than the overall market in good periods, while bonds and inverse leverage ETFs generally perform better in down periods.
Delta – is used in options trading signifying the rate of change in the options price, relative to the underlying asset. For Calls (bullish), the delta ranges from 0 to 1, while for Puts (bearish), it ranges from 0 to -1. Short-term options traders (also known as swing-traders) normally prefer a delta reading in the .6 to .7 range for Calls (or -.6 to -.7 for Puts), as they wish for enough volatility (price movement) to realize quick profits, and generally open option trades with expiration dates approximately 3-4 weeks away. Longer-term options traders generally prefer a lower delta to allow slower, safer, price movement.
Gamma – symbolizes the options risk, measuring the rate of change in delta, based on each 1-point move in the price of the underlying asset. The higher the gamma, the more sensitive the asset is to price change. Gamma is usually the highest when the option is “near-the-money” (close to the strike price) or close to expiration. The further “in-the-money” (better than the strike price - profit) or “out-of-the-money” (worse than the strike price – loss), the lower the gamma tends to be. Technically, the gamma is the “rate of change” of the rate of change (delta), as it determines how much the delta fluctuates with price change. Gamma is used more by day-traders then longer-term investors, but is a good gauge of volatility.
Theta – signifies an options’ time decay, or the rate of change in the value of an option over time. This reading is usually negative, as it measures the speed of decreasing worth of an option due to the time decay. This is important when deciding how long to potentially hold a position, as a slower time decay would allow the purchaser more time to monitor their desired profit or stop loss levels. The faster the diminishing value, the shorter the time to make that choice.
These are a bit more advanced and take a while to fully understand, and you may want to take them one at a time while learning. As always, it is wise for beginners and intermediates, to follow a strict set of consistent rules, which will create less headaches and potential panic. When attempting to trade options, the time factor is essential, and different parameters are generally utilized in comparison to those used when simply buying or selling an underlying stock or ETF. Once again, keep contract sizes small and increase as you gain experience and confidence.
For additional discussions and education, please continue to visit our BLOG section here on ASTRO-FIN, where we provide periodic updates on a variety of topics.
