Option greeks are a set of measures used to describe the sensitivity of the price of an option to various factors. These factors include the underlying asset's price, time to expiration, volatility, and interest rates. The option greeks are Delta, Gamma, Theta, Vega, and Rho.
Delta measures the sensitivity of the option's price to changes in the underlying asset's price. It is expressed as a number between -1 and 1, with a positive delta indicating that the option's price will increase as the underlying asset's price increases, and a negative delta indicating the opposite.
Gamma measures the sensitivity of the option's delta to changes in the underlying asset's price. It is expressed as a percentage, and indicates how much the delta will change as the underlying asset's price changes.
Theta measures the sensitivity of the option's price to changes in the time to expiration. It is expressed as a negative number, with a higher theta indicating that the option's value will decrease more quickly as the expiration date approaches.
Vega measures the sensitivity of the option's price to changes in the underlying asset's volatility. It is expressed as a percentage, and indicates how much the option's value will change as the underlying asset's volatility changes.
Rho measures the sensitivity of the option's price to changes in the interest rate. It is expressed as a percentage, and indicates how much the option's value will change as the interest rate changes.
Together, these option greeks provide a comprehensive picture of the factors that can affect the value of an option. By understanding these greeks, option traders can make more informed and profitable trading decisions.
The Black-Scholes model:
The Black-Scholes model is a mathematical model for pricing options, which are financial derivatives that give the holder the right but not the obligation to buy or sell an underlying asset at a specified price on or before a certain date. The model, which was developed by economists Fischer Black and Myron Scholes in 1973, is widely used by option traders to determine the fair value of an option and to help them make informed trading decisions.
Here are some key points about the Black-Scholes model:
The Black-Scholes model uses several key inputs to determine the fair value of an option. These include the current price of the underlying asset, the option's exercise price (also known as the strike price), the time remaining until the option expires, the option's volatility, and the risk-free interest rate
The model uses a complex mathematical formula to calculate the fair value of an option, taking into account these inputs as well as other factors such as the time value of money and the effects of dividends on the underlying asset
The Black-Scholes model is widely used by option traders to help them determine the fair value of an option and to make informed trading decisions. By comparing the option's fair value to its market price, traders can identify potential opportunities to buy or sell the option at a favorable price
The Black-Scholes model has some limitations and assumptions that need to be taken into account when using it. For example, the model assumes that the underlying asset follows a log-normal distribution, which may not be the case in reality. It also assumes that the underlying asset does not pay dividends, which can affect the option's value
Despite its limitations, the Black-Scholes model remains a widely used and important tool for option traders. It provides a valuable framework for understanding the factors that affect the value of an option, and can help traders make more informed and profitable trading decisions