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What Are the Four Risks of Trading Stock Options?

April 5, 2022 by Daniels Trading| Tips & Strategies

When it comes to trading stock options, traders defer to the Greek language to address risk. Are you familiar with “option Greeks?” In this article, we’ll teach you about the four Greek risk measures of equities options: delta, gamma, theta, and vega.

1. Delta

Delta is the rate of change of a stock option’s price with respect to a change in the underlying stock price. In other words, as stock price changes, the option premium does the same. This relationship is represented as a numerical delta value.

Deltas are assigned to calls and puts as follows:

Calls

When the underlying stock of a call option rises, the value of delta increases. Why? Because as a call option’s stock price rises, so does the premium. Delta has a positive correlation with call options and is represented on a scale of 0-1.00. Stock options with higher deltas exhibit a greater sensitivity to fluctuations in stock price.

Puts

When the price of the underlying stock falls, the value of a put option rises. Thus, a negative correlation is established. Put deltas are represented on a scale of -1.00 to 0. The lower the put delta, the more sensitive the contract is to stock price fluctuations.

2. Gamma

Gamma measures the rate of change exhibited by delta over a period of time. It is a constant value that illustrates the amount of variation in the premium to stock price correlation.

Gamma is used to quantify the relative stability of an option contract’s pricing. For instance, options with high gammas are inherently unpredictable. Conversely, low gammas are sought after because they suggest reduced pricing volatility and a higher probability of expiring at or near current prices.

Generally, gammas are small for contracts that are well out of the money (OTM) or deep in the money (ITM). As a stock option gets near the money, gamma increases.

3. Theta

Theta addresses the options risk posed by time decay. Because options are perishable financial instruments, they lose value as expiration approaches. This occurs because the opportunity to profit from the contract lessens as its time horizon draws to a close.

Functionally, theta quantifies the rate of time decay experienced by an option’s value. Accordingly, theta is always negative for buyers of put and call options. Options writers, in contrast, benefit from theta because their goal is to see the option contract expire worthless.

Theta increases exponentially as contract expiry approaches. For buyers or sellers of stock options, theta is a primary consideration.

4. Vega

Vega is a device used to estimate implied volatility and its potential impact on options pricing. Implied volatility is a term used to describe forthcoming movements in price action.

At its core, vega represents the expectations the market has for volatility in the contract’s underlying stock price. Essentially, calls with higher vegas have a greater chance of trading in the money ahead of expiry, whereas puts with lower vegas are positioned to expire profitably.

As a general rule, vega decreases as a stock option approaches expiry. This is because of a lessened chance of implied volatility swaying an option from ITM to OTM and vice versa.

Stock Options 101: Know Your Risks!

Without a doubt, options are some of the most complex securities on the capital markets. However, many professional traders make a living by trading options and little else. Given their structure, not to mention their flexibility, stock options can help nearly anyone reach their financial objectives.

To learn more, be sure to check out the Daniels Trading blog. Featuring general educational materials and expert analysis, it’s a great place to begin your journey into the markets. Don’t delay—subscribe today!

Sign up for the Daniels Trading Blog today

Filed Under: Tips & Strategies

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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