No lack of OPTIONS

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PebbleTrader
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Postby PebbleTrader » Sat Feb 23, 2013 4:22 pm

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Postby PebbleTrader » Sat Feb 23, 2013 4:54 pm

Theta

The next most commonly encountered Greek is the theta. The
theta provides an estimate of how quickly your option is losing it time
value.

Theta: The amount that the price of an option changes as compared to
the passage of a unit of time (typically one day).

The value of theta is always a negative number, because the value of an
option diminishes over time. In the terminology of options, the loss of
time value is referred to as theta decay.

As a rough guide, the magnitude of theta for an at-the-money option
varies inversely as the square root of the time remaining until expiration.
For example, an option that has 40 days until expiration loses time
value twice as fast as it did when it had 160 days until expiration
[square root (160/40) = 2]. An option that has only 10 days until expiration
loses value 6 times as fast as it did when it had 360 days until
expiration [square root (360/10) = 6].

Some traders make a practice of never holding a long at-the-money
option that has less than three weeks until expiration, because of the
increasing rate at which the option will lose its value. With an out-ofthe-
money option, the situation can be even worse.

An easy way to get a rough measure of the theta of an option is to
compare two options with the same strike price that have different
expiration dates. For example, suppose your at-the-money option has a
value of $4.30 per share with four months until expiration, whereas the
option with the same strike price and only two months until expiration has
a value of $2.50 per share. This means that, if the stock price remains
unchanged over the next 60 days, your option will lose about $1.80 in
value. That translates to a theta of approximately -$.03 per day
[-1.80/60 = -.03], which may not seem like much until you recognize
that it can add up to a 42 percent loss in the value of your option over
the next two months.
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Postby PebbleTrader » Sat Feb 23, 2013 4:59 pm

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Postby PebbleTrader » Sat Feb 23, 2013 5:00 pm

Gamma

Gamma: The amount that the delta changes as compared to a $1 increase
in the price of the stock.

The gamma becomes important in situations where the delta of an
option becomes especially sensitive to changes in the price of the stock.
Such situations are said to have gamma risk. One such scenario in
which gamma becomes important occurs as an option approaches its
expiration date.

As expiration gets close, the usual delta values of in-the-money and
out-of-the-money options become distorted. All in-the-money options
will have a delta closer to one, whereas all out-of-the-money options
will have a delta that is closer to zero. So, a small increase in the stock
price, from slightly below a strike price to slightly above it, will cause a
change in the option delta from near zero to near one. This yields a
large value of gamma. There is considerable risk in such situations,
because a small decrease in the stock price can change a profitable call
into one that is worthless.
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Postby PebbleTrader » Sat Feb 23, 2013 5:09 pm

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Postby PebbleTrader » Sat Feb 23, 2013 5:22 pm

Vega

The "vega" of an option provides a measure of its volatility. Just as
stocks can be volatile, options can also be volatile, although there is not
always a direct correlation of those volatilities. A stock whose price is
volatile will typically have options with inflated prices, but it is also
possible for options prices to inflate with little or no movement in the
underlying stock price.

The point here is that each option has its own individual measure of
volatility that is dictated by its particular price action. In options terminology,
this individual volatility is called the implied volatility.

Vega: The amount that the price of an option changes as compared to a
unit increase in the volatility of the stock.

The importance of vega is seen whenever circumstances surrounding
the stock become excited for any one of a variety of reasons. Rumors
that a stock might be bought out will quickly inflate the prices of the
options associated with the stock. Under such a scenario, there can be a
large increase in the price of an option even if the stock price changes
little. This gives rise to a high vega.
Last edited by PebbleTrader on Sat Feb 23, 2013 5:53 pm, edited 1 time in total.
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Postby PebbleTrader » Sat Feb 23, 2013 5:52 pm

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Postby PebbleTrader » Sat Feb 23, 2013 5:52 pm

Rho

Rho: The amount that the price of an option changes as compared to a
unit increase in the risk-free interest rate (that is, the rate for a U.S.
treasury bill).

Rho is positive for calls and negative for puts.With interest rates at the
relatively modest levels seen in recent years, the influence on the price
of options is slight.
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Postby PebbleTrader » Sat Feb 23, 2013 5:54 pm

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Any questions on the Greeks?
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Postby PebbleTrader » Sat Feb 23, 2013 5:57 pm

So, I'm remembering these like this:

Rho begins with a "R" and "R" = Rate (Like "Interest Rate")

Vega begins with a "V" and "V" = Volatility

Theta begins with a "T" and "T" = Time (like "Time Decay")

...now I just have to come up with something for Delta and Gamma...:)
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