Understanding the option greeks is pivotal to truly understanding and trading options.
As I like to say, the greeks are like the controls on a car. They give you an idea of how the trade should perform based on the underlying, time and volatility. But one thing about the greeks that is often overlooked is how they multiply based on contract size. Let’s take a quick look below.
Here is an example of an options chain. Let’s say an option trader buys one contract of the October 185 calls because he is bullish on the stock.
The current delta is approximately 0.51, which means for every move of $1 on the stock, the option premium should change by that amount. Gamma would change delta by approximately 0.02 for every $1 change. One day of time passing would currently reduce the call premium by about $0.06 based on the theta and a 1% change in implied volatility(NYSEARCA:VXX) would increase or decrease the option premium by about $0.33 based on the current vega.
But what if 2 contracts were purchased? Now an option trader needs to consider that all the greeks get multiplied by 2 for the overall position. A $1 move higher based on delta alone (keeping gamma constant at this point) would increase the premium by $1.02 (0.51 X 2) or $102 in real money. This would be true across the options chain as well. A day passing now results in the overall premium for the position to drop $0.12 (0.06 X 2). So, if an options trader is worried about being exposed in some capacity, he needs to consider position size and/or consider a spread that may limit his exposure.
Knowing what the greeks are and how they can affect your position is paramount for an options trader. Just don’t forget that increasing your position size can affect your profit and loss as well.