Matt Baker |
Welcome to Part 10 of my series on the Greeks. In my last article, we dealt with the sign in front of each Greek (+ or -) changing throughout the life of the trade. In this article we will look into the actual value of each Greek changing, and how to manage these changes.
Some trades start off with a dominant Greek that you have to manage from the outset, and some trades start off with each Greek quite dormant and it’s not until later in the trade that one of the Greeks may rear its ugly head, or pretty face!
An example of a trade from the outset with a dominant Greek is a simple long Call. A long Call’s Greeks could look something like this:
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Delta
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Gamma
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Vega
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Theta
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35.2
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4.1
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$5.60
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-$1.30
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We can see here Delta is the dominant Greek. It’s the Greek that will have the most effect on us, whichever way the stock moves. If the stock goes up one $1, we will make $35.20 and if it goes down $1, we will lose $35.20. Assuming we had selected a low IV stock, we would only make or lose $5.60 a percentage point if IV moved up or down. However if the IV of this stock was high, and Volatility could potentially come down 10 points, that’s 10x $5.60 we could lose, so Vega would also be a dominant Greek in this case. Theta is pretty harmless too – only losing $1.30 a day.
Now down to the Greek management. If the stock goes your way (up), Delta will increase (because Gamma is positive). If the stock went up $5, the Greeks could roughly look something like this.
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Delta
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Gamma
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Vega
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Theta
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65.6
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7.2
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$9.30
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-$9.10
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So the trade is going well, you're making lots of profit, what could be going wrong? Delta needs some management here if you decide it’s getting too large. How do you know if it’s getting too large? When you ask yourself the question “What if I’m wrong?”
If the stock now went down $1, you would lose $65.60. If that’s too much for you to lose and you don’t want that much delta exposure, then you will need to reduce your delta back to a manageable level where you make a little if the stock conforms to your prognosis, but if it doesn’t you wont lose too much. How do you reduce Delta? There are a number of ways – sell off some contracts, close the trade (that will reduce the Delta to 0), or “sell, sell, sell” – sell something against the Calls you have.
Most adjustment moves we make involve selling. This could be selling off some contracts or depending on your prognosis of direction (up, down or sideways), time (how long) and IV levels (and where IV is likely to go), it could be selling other options around the ones you have, at various strikes, months and in various ratios. How to make adjustments and which options to sell in our adjustment moves is an in depth science. You may find your call(s) morph into a long Call Spread, Butterfly, Condor or many other potential strategies, all from starting with a profitable long Call and then selling (and perhaps buying) options around the original position.
The Masters ICT course spends the bulk of its time on adjustments and teaches the trader in depth how to manage the trade. An excellent course!
Manage your Greeks!
Matt Baker
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