Option Greeks

The option Greeks are the sensitivities of the Black-Scholes formula to its various
parameters.
The “Greeks,” as they are called (because of the Greek letters used to denote most
of them), are the partial derivatives of the Black-Scholes formula with respect to its
arguments. They can be thought of as giving a measure of the riskiness of an option:

• Delta, denoted by Δ, is the partial derivative of the option price with respect to
the price of the underlying stock price:

Delta: Δ can be thought of as a measure of the variability of the option’s price when
the price of the underlying changes.

The first Greek is Delta, which measures how much an option's price is expected to
change per $1 change in the price of the underlying security or index.
For example, a Delta of 0.40 means that the option's price will theoretically move
$0.40 for every $1 move in the price of the underlying stock or index.

Call options
 Have a positive Delta that can range from zero to 1.00.
 At-the-money options usually have a Delta near .50.
 The Delta will increase (and approach 1.00) as the option gets deeper in the
money.
 The Delta of in-the-money call options will get closer to 1.00 as expiration
approaches.
 The Delta of out-of-the-money call options will get closer to zero as expiration
approaches.
Put options
 Have a negative Delta that can range from zero to -1.00.
 At-the-money options usually have a Delta near -.50.
 The Delta will decrease (and approach -1.00) as the option gets deeper in the
money.
 The Delta of in-the-money put options will get closer to -1.00 as expiration
approaches.
  The Delta of out-of-the-money put options will get closer to zero as expiration
approaches.
 You also might think of Delta, as the percent chance (or probability) that a
given option will expire in the money.
 For example, a Delta of 0.40 means the option has about a 40% chance of
being in the money at expiration. This does not mean your trade will be
profitable. That of course, depends on the price at which you bought or sold
the option.
 You also might think of Delta, as the number of shares of the underlying stock,
the option behaves like.
 A Delta of 0.40 also means that given a $1 move in the underlying stock, the
option will likely gain or lose about the same amount of money as 40 shares
of the stock.
Example:
The following example should help you understand this better –
Nifty @ 10:55 AM is at 8288
Option Strike = 8250 Call Option
Premium = 133
Delta of the option = + 0.55
Nifty @ 3:15 PM is expected to reach 8310
What is the likely option premium value at 3:15 PM?
Well, this is fairly easy to calculate. We know the Delta of the option is 0.55,
which means for every 1 point change in the underlying the premium is expected
to change by 0.55 points.
We are expecting the underlying to change by 22 points (8310 – 8288), hence the
premium is supposed to increase by
= 22*0.55
= 12.1
Therefore, the new option premium is expected to trade around 145.1 (133+12.1)
Which is the sum of old premium + expected change in premium

• Gamma, Γ, is the second derivative of the option’s price with respect to the
underlying stock. It is an indicator of how the delta value of an option moves in
relation to changes in price of the underlying security. For options priced by the
Black-Scholes formula, the call and put have the same gamma.
Gamma measures the rate of change in an option's Delta per $1 change in the price
of the underlying stock. Since a Delta is only good for a given moment in time,
Gamma tells you how much the option's Delta should change as the price of the
underlying stock or index increases or decreases.

The gamma value of an option indicates how much the delta value of that option will
increase for every $1 price increase in the underlying security or for every $1 price
decrease in the underlying security. It's a positive number regardless of whether you
are buying calls or puts – although it's effectively negative when you write options.
For example, imagine you have a call with a delta of .60. If the price of the
underlying security rises by $1, then the price of the call would therefore rise by
$.60. If the gamma value was .10, then the delta would increase to .70. This means
that another $1 rise in the price of the underlying security would result in the price
of the option increasing by $.70, and the delta would also increase again in
accordance with the gamma.

• Vega is the sensitivity of the option price to the standard deviation of the
underlying stock’s return σ: For no obvious reason, the Greek letter kappa, κ , is
sometimes used to denote vega. Given the Black-Scholes formula, calls and puts
have the same vega:

Vega measures the rate of change in an option's price per 1% change in the implied
volatility of the underlying stock. While Vega is not a real Greek letter, it is intended
to tell you how much an option's price should move when the volatility of the
underlying security or index increases or decreases.
 A drop in Vega will typically cause both calls and puts to lose value.
 An increase in Vega will typically cause both calls and puts to gain value.

For example if Nifty is at 8000. Assuming the 7900 call option is available at a
premium of 130, then the intrinsic value of this option is 100 (the difference between
the spot price and the strike price of the option). The time value is 30. When Vega
increases, only the time value is affected. This 30 can increase to say 32 depending
on the volatility increase.

Similarly, when the news is out and uncertainty dies down, volatility decreases. This
in effect decreases the premium of the options. This is where most trades lose
money. Vega has such a big effect that sometimes even if the direction is right, an
option buyer loses money because Vega decreased.
• Theta, θ, is change in the option’s value as the time to maturity decreases. We
generally expect that options become less valuable with the passage of time (though
this turns out not to be always true). Writing T as the option’s remaining time to
maturity, we set theta equal to the negative of the derivative of the option price with
respect to T :

All options – both Calls and Puts lose value as the expiration approaches. The Theta
or time decay factor is the rate at which an option loses value as time passes. Theta
is expressed in points lost per day when all other conditions remain the same. Time
runs in one direction, hence theta is always a positive number, however to remind
traders it’s a loss in options value it is sometimes written as a negative number. A
Theta of -0.5 indicates that the option premium will lose -0.5 points for every day
that passes by.
For example, if an option is trading at Rs.2.75/- with theta of -0.05 then it will trade
at Rs.2.70/- the following day (provided other things are kept constant).
A long option (option buyer) will always have a negative theta meaning all else
equal, the option buyer will lose money on a day by day basis. A short option (option
seller) will have a positive theta.
• Rho, ρ, measures the interest rate sensitivity of an option:
Rho measures the expected change in an option's price per 1% change in interest
rates. It tells you how much the price of an option should rise or fall if the “risk-
free” (U.S. Treasury-bill)* interest rate increases or decreases.
 As interest rates increase, the value of call options will generally increase.
 As interest rates increase, the value of put options will usually decrease.
 For these reasons, call options have positive Rho and put options have negative
Rho.
Problems:
1. Consider the call option on a stock with following parameters:
Strike price Rs. 80
RFR 7.5% PA
Time to expiration 90 days
SD of returns of the stock 0.35
Spot price of the stock Rs. 100
Compute:
a. Price of the call option
b. Price of the put option
c. All Option Greeks

2. For the following data, value the call option and compute all the option Greeks under the
Black and Scholes model.
Stock price Rs. 350
Months to expiration 2 months
RFR 8% PA
SD of stock 30%
Exercise price Rs. 390
Option style European

3. Calculate the value of the call option using BS model given the following information:
CMP of the share is Rs. 750
SD of the stock 0.50
Exercise price Rs. 740
RFR 7.5% PA
Time to expiry 3 months
If the investor wants to buy a put option with the same exercise price and expiry date as
call option, what will be the value of put option? Also, calculate all Option Greeks.
Computing the Greeks:
VBA for Greeks
Function dOne(stock, exercise, time, _
interest, divyield, sigma)
dOne = (Log(stock / exercise) + _
(interest - divyield) * time) / _
(sigma * Sqr(time)) + 0.5 * sigma * _
Sqr(time)
End Function
Function dTwo(stock, exercise, time, _
interest, divyield, sigma)
dTwo = dOne(stock, exercise, time, _
interest, divyield, sigma) - sigma * _
Sqr(time)
End Function
Function BSMertonCall(stock, exercise, time, _
interest, divyield, sigma)
BSMertonCall = stock * Exp(-divyield * _
time) * Application.NormSDist _
(dOne(stock, exercise, time, _
interest, divyield, sigma)) - exercise * _
Exp(-time * interest) * Application.NormSDist _
(dTwo(stock, exercise, time, interest, _
divyield, sigma))
End Function
'Put pricing function uses put-call
'parity theorem
Function BSMertonPut(stock, exercise, time, _
interest, divyield, sigma)
 BSMertonPut = BSMertonCall(stock, exercise, _
time, interest, divyield, sigma) + _
exercise * Exp(-interest * time) - _
stock * Exp(-divyield * time)
End Function
'The standard normal probability density,
'this is N'(x)
Function normaldf(x)
normaldf = Exp(-x ^ 2 / 2) / _
(Sqr(2 * Application.Pi()))
End Function
Function DeltaCall(stock, exercise, time, _
interest, divyield, sigma)
DeltaCall = Exp(-divyield * time) * _
Application.NormSDist(dOne(stock, exercise, _
time, interest, divyield, sigma))
End Function
Function DeltaPut(stock, exercise, time, _
interest, divyield, sigma)
DeltaPut = -Exp(-divyield * time) * _
Application.NormSDist(-dOne(stock, _
exercise, time, interest, divyield, _
sigma))
End Function
Function OptionGamma(stock, exercise, time, _
interest, divyield, sigma)
temp = dOne(stock, exercise, time, _
interest, divyield, sigma)
 OptionGamma = Exp(-divyield * time) * _
Application.Norm_S_Dist(temp, 0) / _
(stock * sigma * Sqr(time))
End Function
Function Vega(stock, exercise, time, _
interest, divyield, sigma)
Vega = stock * Sqr(time) * _
normaldf(dOne(stock, exercise, _
time, interest, divyield, sigma)) _
* Exp(-divyield * time)
End Function
Function ThetaCall(stock, exercise, time, _
interest, divyield, sigma)
ThetaCall = -stock * normaldf _
(dOne(stock, exercise, time, _
interest, divyield, sigma)) * _
sigma * Exp(-divyield * time) / _
(2 * Sqr(time)) + divyield * stock * _
Application.NormSDist(dOne(stock, _
exercise, time, interest, _
divyield, sigma)) * Exp(-divyield * time) _
- interest * exercise * Exp(-interest * _
time) * Application.NormSDist _
(dTwo(stock, exercise, time, _
interest, divyield, sigma))
End Function
Function ThetaPut(stock, exercise, time, _
interest, divyield, sigma)
 ThetaPut = -stock * normaldf _
(dOne(stock, exercise, _
time, interest, divyield, sigma)) * _
sigma * Exp(-divyield * time) / _
(2 * Sqr(time)) - divyield * stock _
* Application.NormSDist(-dOne(stock, _
exercise, time, interest, divyield, _
sigma)) * Exp(-divyield * time) _
+ interest * exercise * Exp _
(-interest * time) * Application.NormSDist _
(-dTwo(stock, exercise, time, _
interest, divyield, sigma))
End Function
Function RhoCall(stock, exercise, time, _
interest, divyield, sigma)
RhoCall = exercise * time * _
Exp(-interest * time) * _
Application.NormSDist(dTwo _
(stock, exercise, time, interest, _
divyield, sigma))
End Function
Function RhoPut(stock, exercise, time, _
interest, divyield, sigma)
RhoPut = -exercise * time * _
Exp(-interest * time) * _
Application.NormSDist(-dTwo _
(stock, exercise, time, interest, _
divyield, sigma))
End Function