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The Greeks Options Are Not Stocks

Sebencapital

Published
22/12/23
The Greeks Options Are Not Stocks

Different Trading Skills Are Required

As a trader or investor, your primary aim is making profits, while your second aim is maximizing gains with minimal risk. Achieving this balance often requires practice and experience.

Many believe that buying an asset and selling it later at a higher price leads to profits in the market. However, with options, things aren't always that straightforward. New traders in this area often face unexpected losses due to the unpredictable behavior of option prices, leading to a gap in their understanding.

Here, we'll explore the tools that options provide and how to use them to earn profits while managing risks effectively.

Adjusting to Options Trading

New options traders often encounter a challenge when they approach options trading similarly to standard stock trading. Options are essentially contracts that give you the right to make future decisions. When you buy an option for a security, you're reserving the choice to buy that security later. Using options to reach financial goals can be complex due to various factors and potential outcomes. Buying options offers a lot of control, allowing favorable results if used wisely.

Experienced traders don't just buy stocks; they also sell short, aiming to make money when stock prices go down. Many new options traders don't think about selling options (while minimizing risk) instead of buying them.

Note

"Selling short" is a method where you sell a stock and then swiftly buy it back, aiming to profit from the price drop that occurs in the meantime.

The Greeks Mathematical Tools

Options are unique investment tools that offer traders more possibilities beyond just buying and selling individual options. Their characteristics stand out in the world of investing.

Options come with a special set of tools called "Greeks," which help traders measure risk. Learning this is essential for new traders. Being able to measure risk is crucial because if you know the maximum potential gain or loss for a position, you can take steps to reduce it. Savvy traders use this knowledge to avoid unexpected losses by understanding the worst-case scenario for their trades.

Traders need to understand the potential reward for a position to determine if it's worth the risk they are taking. Knowing the potential gain helps traders evaluate whether the expected reward justifies the risk involved in the trade.

Here are some methods options traders use to measure the potential risk and reward of their trades.

Loss Over Time (Theta)

Options lose value gradually over time, unlike stocks. Theta, represented by a Greek letter, measures how much an option's value decreases with each passing day.

Note

Unlike stocks, options lose value as time passes. This happens because options derive their value from the right to buy or sell something, and this right expires on a specific date. Once the option is exercised or expires, it loses its value.

Change in Price (Delta)

Delta measures how much an option's price changes when the stock or index it's based on moves up or down. When the stock goes higher or lower, the gains or losses from the option also change, and the value of the option to buy or sell the stock on a specific date shifts too. Delta isn't fixed and can be positive or negative. Some traders use delta to estimate the chance of an option ending in a profitable position (in-the-money or ITM).

Ongoing Price Change (Gamma)


Gamma, a Greek symbol used in options trading, measures how quickly the delta of an option changes when the stock price moves. It's a bit more intricate because it depends on a factor that keeps changing.


Monitoring changes in value and associated risks differs significantly between stocks and options. In stocks, the value shifts by ₹1 for each ₹1 change in the stock price, whereas options value and risk change differently, and this is essential for new options traders to understand.

A Changing Volatility Environment (Vega)

In the stock market, stability usually means smaller gains or losses, while instability leads to larger daily price swings for stocks. However, in the options market, the pricing of options is greatly influenced by market volatility. Vega measures the amount an option's price changes when expected volatility changes.

Hedging With Spreads

Options are frequently used together with other options, like buying one while selling another at the same time. While it might seem complicated, the basic concept is straightforward: if you can anticipate how a particular asset will perform, you can create option setups that make profits if your predictions are correct. Stocks, indexes, and other assets often follow these market patterns:

  • Bullish (the price rises, by 20% to be proper)
  • Negative or Pessimistic (the price falls, say by 20%)
  • Stable (predicting a market that remains within a specific range)
  • Becoming significantly more or less volatile.

There are many ways to mix options, and the advice on how to do it is plentiful; the most popular methods involve spreads. Spread trading happens when you buy and sell multiple options at the same time. This helps spread the risk of losing money across different assets. Traders using spreads predict an overall profit by analyzing the difference between prices.

Spreads have boundaries in terms of both risk and rewards. Although trading spreads is generally safer, it offers a higher likelihood of making money rather than facing significant losses. However, it may not yield huge profits. For beginners in options trading who are cautious about taking big risks, trading spreads and making a reasonable profit across a range might be a good fit. Unlike options, stock traders don't have spreads as a strategy.

The Bottom Line

Options trading differs from stock trading. Savvy options traders find this beneficial because they can create strategies to make money from various stock market situations while keeping the risk controlled.


Written by Sauravsingh

Techpreneur and adept trader, Sauravsingh Tomar seamlessly blends the worlds of technology and finance. With rich experience in Forex and Stock markets, he's not only a trading maven but also a pioneer in innovative digital solutions. Beyond charts and code, Sauravsingh is a passionate mentor, guiding many towards financial and technological success. In his downtime, he's often found exploring new places or immersed in a compelling read.

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