The Greeks & Their Mystery Unveiled! - Part 14

Welcome to part 14 of my series on the Greeks. In last weeks article we constructed a sample portfolio of three trades, and looked at the overall portfolio Greeks. The trades were 3 May long calls on the SPY (S&P500), 3 May short call spreads on AAPL (Apple Computers), and 2 May/June Put Calendar Spreads on GOOG (Google). For more details, please see article Part 13. The three trades are listed below, as well as the overall portfolio Greeks. Let me add that each trade was constructed to be as close to $1000 of risk as possible:

The homework task from the last article was to look at the Greek totals here and assess whether you like them or not. The answer to your homework should be “it depends”. It depends on our view as a whole, and our views on the individual trades. Is there anything here that looks strange? The answer is yes, in that we have both positive Gamma and Positive Theta, where we learned earlier that Gamma and Theta would always have opposing signs to each other as one acts as a trade off for the other. Seeing both positive means we make money with movement and at the same time we’re making money from time decay. But in reality it’s not really as great as that. These Greeks are as of this trading day, with the three stocks at their given prices, with IV at what it is. They will change as these variables change.

If these 3 stocks were similarly correlated, we could say that overall we’re bullish, as we have 98 Deltas, but in reality, the SPY, Apple and Google are like 3 individual machines. We may have a trading day where the SPY doesn’t do much, and Apple goes up, and Google goes down. It is also very important to note the actual point movement. On some days for example, the SPY may move 1 point, where as Google will move 15 points, and Apple 6 points. Now this puts the Greeks into a new perspective. The Delta of Apple is a lot less than the Delta of the SPY, but if the SPY went down 1 point, we’d lose $127, and if Apple went down $6, we’d make (roughly 6points x 24Deltas) = $144. So because on an average trading day Apple moves more ‘points’ than the SPY, the effect of Apples Delta is actually much higher! In other words, the money made or lost on Apple in one trading day ‘could’ be similar to the amount made or lost on the SPY, even though the Deltas appear quite different.

Now your Greek analysis does not have to go this deep. I’m just taking you into their world to help you understand them better. Really we should just apply some common sense to monitor our portfolio Greeks. For example, even though overall we have positive Deltas, and we have a trade on Apple, it doesn’t mean we are bullish on Apple. We have negative Deltas on Apple! So regardless of the overall Greeks, if you become bullish on Apple, you need to look at it individually and adjust the trade so you have positive Delta.

Manage your Portfolio Greeks!

Matt Baker