Option Information.
Dear Insider—Jeff Bishop here.
Meme stocks have been all the rage this month. And while this trend will come and go—there is one theme that I believe will have greater staying power—options and the incredible leverage they offer the retail trader.
In previous posts we’ve had Jason Bond explain what gamma squeezes are.
But today I want to pull back a little...and talk about some of the basics option principles.
Why?
Because I believe there is a lot of opportunity for everyday folks to take advantage of them...but without a proper knowledge base...they’ll either get discouraged or make avoidable mistakes.
So let’s get started…
Below is a screenshot of an option chain for NUGT from a few years ago, when the ETF was trading at $7.64. The closest calls to being at-the-money are Feb $8 calls. The yellow highlighted rectangle, along with the in-the-money $7 calls, are displayed below.
Greek Interaction.png
In this lesson I’ll discuss the behavior of an option based on the Greeks. Keep in mind these changes are not constant. With every tick, every one of them changes.
Let's start with a review of the four main Greeks: Delta, Gamma, Theta, and Vega.
Delta
Delta is the most straightforward of the Greeks. It tells you how much your option will move if the underlying stock moves $1.00 (in either direction). When an option is at-the-money, Delta is approximately 50. The more out-of-the-money the option is, the lower Delta will be. The more in-the-money, the higher it will be.
An excellent way to look at this is this: One option contract leverages 100 shares, all things being equal, an option with a Delta of 50 is like holding 50 shares. A very deep in-the-money option will move very much like a stock position.
At expiration, the Delta of an option will be either 0 or 100 for a call. In other words, calls expiring at least one penny in-the-money will be converted to stock and options. For put options, the Delta ranges are 0 to -100 and work the same way.
Gamma
Gamma tells us the amount by which Delta will change for every dollar move in the underlying stock. The higher Gamma is, the bigger the move in Delta will be. Gamma is expressed in fractions of a dollar. So, the Delta of an option with a 25 Gamma will increase or decrease by .25 for every $1.00 move (up or down) in the price of the underlying stock.
Gamma is the same for both puts and calls. Gamma is positive if you are long and negative if you are short. Gamma is highest when an option is at-the-money and decreases as an option gets deeper in-the-money or deeper out-of-the-money. As with all the other Greeks, Gamma changes as the price of the underlying stock changes.
Gamma can be very sensitive as we approach expiration. As noted with Delta, an option will either close in-the-money or expire worthless. That said, Gamma can move the final week of expiration.
You've probably noticed with AMC and CLOV recently.
Gamma is essential to watch as we approach expiration. For example, traders who short options with low Delta's might think it's safe. However, they forget to consider how quickly that can change. By reviewing your Gamma exposure, you'll avoid making that mistake.
Theta
Theta tells how much the price of an option will change over one day. This number is variable and accelerates as we approach expiration.
It is highest when an option is at-the-money only because there is no intrinsic value in the option, making up only time value. While it is highest when an option is at-the-money, Theta will decrease as the option gets deeper in-the-money.
Theta Value vs Price.png
An option that is deep in-the-money is made up of mainly intrinsic value. On the other hand, Theta may be small in nominal terms for an out-of-the-money option but relative to the option price Theta is high.
Theta increases over time at an exponential rate as the option nears expiration. At expiration, at-the-money and out-of-the-money options will expire worthless as Theta erodes.
And, finally, as the image below demonstrates, the further away from expiration an at-the-money option is, the smaller Theta will be.
Distant Thetas.png
Whether you're long a call or put, your position will have a negative Theta--- time is working against you. On the other hand, a seller of options has a positive Theta. Option sellers benefit from time decay.
