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Welcome to Part 9 of my series on the Greeks. In this article we will continue to piece together the Greeks and learn how to manage them throughout the life of the trade. In part 8, we talked about choosing the Greeks in line with your view and in part 9, we will talk about how the Greek signs change as the trade progresses.
The Greeks can change over the life of a trade. They may change if the stock moves in or out a certain area, or they may change as time goes by. Most of the time, the part of the risk graph where some of the Greeks change is at the point where the coloured time lines converge. There are two factors to manage here. One is the sign in front of the Greeks and the other is the actual value of the Greek. We’ll just be dealing with the sign of the Greeks here.
In a Long Call example below (Chart 1), there are no points where lines converge, so Delta, Gamma and Vega will always be positive, and Theta always negative. Although the signs won’t change, the values of all the Greeks will certainly change every day.
Chart 1
click to enlarge
In the example of a Bull Call spread below (Chart 2), there is a point where the lines converge, at point 3. In the Bull Call Spread, Delta will remain positive, but after the point of convergence of the coloured lines Gamma will become negative, Vega will become negative and Theta will become positive. Even without knowing this, the risk graph lines tell us this. In that upper part of the risk graph between points 3 and 5, you can see that as time passes by the coloured lines get pulled into the black expiration line, but this time it’s to the right, not to the left – in the direction of profit. So clearly Theta has to be positive here.
Gamma is a hard one to recognize, but if you look carefully you’ll see that the slope of the curve from this point on gets steeper and steeper, which means delta is slowing down for each dollar move up, and makes less and less. This slowing down of the Delta is made by the Gamma changing from positive to negative. Gamma either feeds Delta, or takes away from it. If Delta starts decreasing as it does from point 3 and, then it’s the negative Gamma which is doing this. You may remember from a previous article that Gamma and Theta will always have the opposite signs to each other. This is another indicator that Gamma will become negative, when Theta becomes positive.
Chart 2
click to enlarge
Being aware of where the Greek values change signs can really help you manage the Greeks in a trade. You need to decide whether that Greek changing will help you, make no difference, or perhaps hinder you. Given that decision, the point where certain Greek changes may be the point you either close or adjust the trade.
I'm writing this article in the Sydney Masters Interactive Computer Trading class, the best place to be if you want to learn advanced options trade adjustments!
Manage your Greeks!
Matt Baker
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