Options trading is a form of trading stocks. When deciding on what option to invest in, you need to consider a few factors first, and looking at the Greeks can tell you a lot about the sensitivity of your option. Let’s explore options trading and the Greek theta.
What Are Options?
Options trading is a more tedious version of trading stocks. Options are contracts that give you the right to buy or sell a stock at a set rate by a specific date. One benefit of an option is that you have no obligation to act on it by the end date. Although options are speculative by nature, if you time it right, you can make a considerable profit.
Put vs. Call Options Contracts
There are two types of options: put and call. A call option gives you the right to buy a stock at a set price by a set date. A put option is the opposite, so it gives you the right to sell a stock at a set price by a set date. Each of these options can be quite beneficial to your portfolio. For instance, if you buy a call option, you have the chance to buy a stock much cheaper than what it will be worth by the expiration date. If you sell a put option, you may be able to sell a stock for more than it’s worth.
What Is Theta?
Theta measures the value of an option based on how much time is left before it expires. Essentially, theta is the time decay of an option and tells you how much value your option will lose each day. It tells you how much the underlying asset must increase or decrease in order to offset its loss in value. The rule of thumb is that the closer your option gets to expiring, the more value it will lose.
When Theta is Useful
Theta can help you determine whether to go long or short on an option. If you choose to go short, there may not be enough time for the stock to change in your favor. However, if you anticipate that the stock will remain flat, then going short may be the right choice.
Going long on an option may be a smart decision if you anticipate that the stock will shift. Even though you lose value on the option every day, the change in the stock may offset this loss. Like any other underlying asset, an option comes with risk.
The Other Main Greeks
Along with theta, you can learn even more about your option by looking at these Greeks:
- Delta: The measurement of the impact of the underlying asset’s change of price. The delta value of a put option ranges from 0 to -100 while the delta value for a call option is 0 to 100.
- Gamma: The measurement of delta’s rate of change. It’s useful when predicting how much you could gain or lose based on the movement of the underlying position.
- Vega: The measurement of the impact of a change in volatility. This Greek looks at future volatility while delta looks at actual price changes.
When investing in an option contract, always consider the risks. Start by looking at the Greeks to assess its value.