Aug 10 2008
Second Tier Greeks
According to Options University Guru Ron Ianieri, an ex option market maker and author of the University’s Advanced Option Strategy Course, most option traders aren’t being taught correctly. For instance, Ron begins with the option pricing model and builds up to strategies. Most stock option courses focus on strategy while understanding the importance of risk evaluation goes by the board in an attempt to pitch a system or software. For example, Options University’s Advanced Options Strategy Course begins up front with understanding the subtleties of the Option Pricing Model and the many treasures it reveals. For example, Second Tier Greeks are discussed in detail. Most option traders aren’t even familiar with the First Tier Greeks much less the second tier. Are you?
For stock option traders, it’s a must to understand the concepts of the Greeks. The most notable of them are: Delta, Gamma, Theta and Vega. These “First Tier Greeks” are key to evaluating pricing and options sensitivity to changing variables. As a quick refresher (if the Greeks are something new, you need to take the course immediately-it’s that important) let’s review the most widely known Greeks as revealed in modern stock option pricing models.
- Delta is known as the first derivative. Delta tells us how much an option’s price will change with a movement in the underlying stock price.
- Gamma tells us how much the option’s Delta will change with a one-dollar movement in the stock.
- Theta means time decay and tells us the rate at which an option’s price will decay on a daily basis.
- Vega is The amount that the price of an option changes
All of the First Tier Greeks are the first derivatives of the Pricing Model and are crucial to the analysis of stock options-particularly Delta. But the Second Tier Greeks are hardly mentioned anywhere. Ron Ianieri feels that is a big mistake. What are the Second Tier Greeks, anyway?
The Second Tier is the second derivatives of the First Tier Greeks. More specifically, they measure, using a number, the change in a first-tier Greeks caused by changes in volatility and time.
Meet the Second Tier
- V-Delta (V-Del) measures a change in volatility’s effect on Delta.
- T-Delta (T-Del) measures the passage of time’s (Theta’s) effect on Delta
- V-Gamma measures a change of volatility’s effect on Gamma
- T-Gamma measures the passage of time’s effect on Gamma.
- V-Theta measures a change in volatility’s effect on Theta.
V-Delta connects volatility and Delta. A positive V-Delta (or V-Del) tells the trader that for each tick that volatility moves, Delta position will either increase or decrease by a set amount. This becomes important when a stock has a major volatility move. I am not talking a tick or two. I’m talking a minimum of 10 to15 ticks, a 20, 30, 40 percent increase. A trader should know what real Delta is at a new volatility level. V-Del tells you that.
T-Delta, measures the Theta to Delta relationship. It tells option traders how their Delta position will change (by what amount) with the passage of time. T-Del helps when you are going to be away from your position for a time. T-Del tells traders what they can expect when they return.
V-Gamma is not as important as V-Del, but according to Ron, option traders need to know what their position’s Gamma is at all times under every condition in order to trade it effectively.
T-Gamma works in a similar way as V-Gamma, except that the T-Gamma relationship is not evaluating changes in implied volatility.
V-Theta measures the affect of a change in volatility on Theta.
When implied volatility goes up, prices go up; when implied volatility goes down, prices go down. V-Theta, or the volatility to Theta relationship, basically tells the option trader, with a number, how much your decay is going to change with a movement in implied volatility?
Ron Ianieri, designer of the Options University Advanced Options Strategy Course states upfront that stock option traders need to be properly instructed on how different changes in the different influencing factors of option pricing will affect their stock option positions and that understanding what these measurements tell the option trader needs to be understood before discussing strategies. More specifically, second tier Greeks help the option trader understand what can happen to positions before it happens-not after.
For more information on the courses offered by Options University, go to www.optionsuniversity.com .
Get your free 7 Deadly Sins Report and click here, presented by Options University, and register now for the Forex World Currency Options Class with Greg MaDermott, starting August 18, 2008.
If you are interested in joining Options University’s affliiate program please sign up here.
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