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Software for Pricing Options
by Kenneth R. Trester
and Robert P. Swanson
Chapter 6 - Behold the "Greeks"
OPTION MASTER® for Windows, DOS and the Newton will calculate
the Delta, Gamma, Theta and Vega. Professionals frequently use
these ratios to create Delta neutral strategies where they profit
regardless of what the market does. But "Delta neutral"
strategies involve a lot of trading to keep the position neutral
and therefore are not advised unless you are on the floor of an
exchange.
These four ratios are again defined below:
- DELTA -- is the percent of a point that the
theoretical value of an option will change for a
one-point change in the underlying stock, index or
futures. For example, if a call stock option has a
Delta of .50, the stock option will move up 1/2 of a
point for every point that the stock moves up one
point.
-
- GAMMA -- is the amount the Delta will change
if the underlying stock index or futures changes one
point. For example, if the Delta is .50 and the Gamma
is .10, if the stock price increases by one point,
the Delta will increase to .60 (.50 + .10 = .60).
-
- THETA -- is the time decay factor and is the
rate at which an option will lose value as each day
passes. For example, a Theta of .33 indicates that an
option price will decrease in value .33 of a point as
each day passes.
-
- VEGA -- is the point change in the theoretical
value of an option for a one percentage point change
in volatility. For example, if an option has a Vega
of .50 to each percentage point increase in
volatility, the option will gain 1/2 of a point.
The Delta is the most valuable ratio for most option
traders. If you are an options buyer, you want a high
Delta, and if you're an options writer, you want a low
Delta.
To calculate the "Greeks," click on Calculate
in the main menu bar and then select Ratios and then
select whether you want Futures Options or Stock and
Index Options.
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