Option Greeks Multiply Like Rabbits

To be successful at option trading, one has to master a variety of elements. One of them, and some say maybe the most important, is understanding the option greeks. As Dan Passarelli likes to say, the greeks are like the controls and gauges on a car. They give you an idea on how the trade should perform based on the underlying, time and volatility. But one thing about the greeks that is often overlooked is how they multiply based on contract size. Let’s take a quick look below.

Here is a very recent example of an options chain. Let’s say an option trader buys one contract of the November 197.5 calls because he or she is bullish on the stock.

The current delta is approximately 0.64 (rounded down), which means for every move of $1 on the stock, the option premium should change by that amount ($64 in real terms). Gamma would change delta by approximately 0.02 (rounded up) for every $1 change in the underlying. One day of time passing would currently reduce the call premium by about $0.18 (rounded down and $18 in real terms) based on the theta. A 1% change in implied volatility would increase or decrease the option premium by about $0.19 (rounded down and $19 in real terms) based on the current vega.

But what if 3 contracts were purchased instead of just 1? Now an option trader needs to consider that all the greeks get multiplied by 3 for the overall position. A $1 move higher based on delta alone (keeping gamma constant at this point) would increase the premium by $1.92 (0.64 X 3) or $192 in real money. This will be true across the options chain as well. A day passing now results in the overall premium for the position to drop $0.54 (0.18 X 3). So, if an options trader is worried about being exposed in some capacity, he or she needs to consider position size and/or a spread to potentially limit his exposure.

Knowing what the greeks are and how they can affect your position is paramount for an options trader. Just don’t forget that increasing your position size not only increases your potential profit and risk, it also multiplies all the greeks and changes are magnified.

John Kmiecik, Market Taker Mentoring

Trader Education