Are you a crypto investor looking to options as a way of hedging risk, but feeling a little daunted by all the Greek jargon floating around?
Don’t worry, you’re not alone! The Greeks in Options trading can be a confusing concept for even the savviest of investors. Those who actually learn them enough to have a working knowledge have obviously slugged it out and have some pretty hardcore stamina.
So, in this article, we’re going to break it down for you, and if that’s not enough, well, we’re going to show you how World Champion traders can hedge risk without ever having to go anywhere near the Greeks!
Just a little note. If at any point during this article you start to find your head hurting, it’s highly recommended to scroll straight down to the summary!
First things first, let’s talk about what the Greeks are in relation to options trading.
These are a set of variables that are used to calculate and measure the risks and rewards associated with an options trade. They’re so named because they are the letters of the Greek alphabet that are used to represent the various risk measures associated with an options trade.
The use of the Greek alphabet for these variables is believed to have originated with the work of Fischer Black and Myron Scholes, who developed a mathematical model (creatively called Black-Scholes) for pricing options in the 1970s. The use of Greek letters to represent these risk measures has since become a standard convention in the field of options trading.
The most commonly used Greeks in options trading are Delta, Gamma, Theta, and Vega. More on what these are, shortly, but first, let’s understand why you need to know your Greeks if you’re going to be a successful options trader.
The Greeks provide a way to measure and manage the various risks associated with an options trade, such as time decay, volatility, and changes in the underlying asset’s price.
Traders with a good grounding in the Greeks make more informed decisions about when to enter and exit a trade, and how to adjust their positions to maximize their potential returns.
You can of course go and start trading options without knowing your Greeks, but if you do that, you’re missing out on some seriously important data that’s used by institutions and professionals who are determined to take your money from you.
So should you decide to start playing options without some knowledge of the Greeks, we wish you the best of luck, as this is somewhat akin to putting your money on red or black at a Roulette table.
But, surely, it can’t be that hard to learn Options, right?
Of course not — read on to find out what you need to know if you’re going to start Options trading.
The first of the Greeks we are going to look at is Delta.
Delta measures the change in the price of an option relative to a change in the price of the underlying asset.
Delta can be a positive or negative number (depending on whether the option is a call or put) and is calculated by taking the derivative of the option’s price with respect to the price of the underlying asset. Yes, we know, that’s one of those sentences you tend to have to read a couple of times. Let’s try to make it simpler with an example.
A Delta value of 1 means that the option’s price will increase by $1 for every $1 increase in the price of the underlying asset.
Conversely, a Delta value of -1 means that the option’s price will decrease by $1 for every $1 increase in the underlying asset’s price.
Imagine you buy a call option on an asset.
If the price of the asset increases by $1, the value of your call option will also increase. This is because the option gives you the right to buy the asset at a certain price, and if this assets’ price increases, the option becomes more valuable.
In this case, the option’s Delta would be positive, because its price is increasing along with the asset’s price.
Now, let’s suppose that instead of a call, you bought a Put on the asset, and in this case, the option’s Delta would be negative. This is because a put option gives you the right to sell the asset at a certain price, and so, if its price increases, the option becomes less valuable.
So, in this example, should the price increase by a dollar, the value of your put option will decrease by the same amount.
Easy… right? That was a pretty simple first round, wasn’t it?
Let’s talk now about Gamma. Unfortunately, Gamma is probably the hardest of the Greeks to wrap your head around — and (here comes the rub) it’s also one of the most important.
Gamma measures the rate of change of Delta (got that?).
This is calculated by taking the second derivative of the option’s price with respect to the price of the underlying asset.
A Gamma value of 1 means that the option’s Delta will increase by 1 for every $1 increase in the price of the underlying asset.
But here’s where it gets even trickier because Gamma is not a static value — it changes as the underlying asset’s price changes.
So how exactly can knowing Gamma help the average Joe options trader? Well, by understanding Gamma, you can understand how to achieve a Gamma-neutral position, which protects against large shifts in the value of the assets.
Gamma hedging means creating a portfolio of assets whose rate of change (delta), is close to zero, and it involves adjusting the portfolio by adding (or removing) additional option contracts.
For example, if a trader holds a large number of call options, they might add a small put-option position to offset any potential losses from a sudden drop in the underlying security’s price.
In essence, Gamma hedging requires careful calculation to be done effectively, meaning traders have to constantly monitor and adjust their positions to take Gamma into account.
It can be a lot to keep track of, especially when you’re trying to manage multiple trades at once, and if you’re still adamant about Options trading, you’re going to need to fire up the spreadsheet skills too!
Oh, you thought Options trading was going to be oh-so easy, didn’t you? Are you starting to feel a bit pummelled yet?
Theta measures the rate of change in the option’s price over time. This is important because options have an expiry time, and as that time gets closer, the option becomes less valuable.
Theta is a measure of the risk of time decay for an option.
It is typically expressed as a negative number for long positions, as the option's value decreases as time passes. When the option reaches its expiration date, the theta value will be zero, as the option will no longer have any time value.
As such, theta is always negative for long options and will always reach zero at expiration.
In other words, a Theta value of -1 means that the option’s price will decrease by $1 for every day that passes.
Okaaayyyy… Clear? Well, let’s look at an example and make sure you’ve got it:
Let’s say you own a call option on an asset, and this option has a Theta value of -0.5, meaning its price will decrease by $0.50 for every day that passes because as time goes on, the option becomes less valuable (even if the price of the underlying asset stays the same).
Surely that makes perfect sense, and you should now be feeling pretty good about how it’s going…
If you’re still with us at this point, let’s move on to our final Greek, Vega.
Vega is a measure of the sensitivity of an option’s price to changes in volatility and is calculated by looking at the option’s price with respect to the volatility of the underlying asset. Hang on, let’s just recap on what volatility is.
Volatility is a measure of the size and speed of price movements. It can be calculated based on recent price changes, historical price movements, and expected future price changes in the asset. Basically, it’s how much the price moves and how quickly. Cryptocurrencies are wildly volatile, especially when compared with most stocks in the traditional financial markets.
It’s important to understand that Vega measures the sensitivity of an option’s price to changes in volatility, not volatility itself.
As you’d expect after surviving so many other rounds on the other Greeks, a Vega value of 1 means that the option’s price will increase by $1 for every 1% increase in the volatility of the underlying asset.
Let’s say you own a call option on an asset which has a Vega value of 0.5, meaning that its price will increase by $0.50 for every 1% increase in the volatility of the underlying asset.
As volatility increases, your call option becomes more valuable because higher volatility means that the asset’s price is more likely to move in a direction favourable to the option.
If you own a put option on an asset, the Vega value would be negative, and the Vega value indicates how much the option’s price will decrease for every 1% increase in the volatility of the underlying asset.
How are you feeling now?
So there we have it. By now, you should be an expert in options, ready to go and place your bets and make a ton of money. Aren’t you?
We’re not going to sugar-coat it — learning the Greeks is no walk in the park, especially for those people who are new to the world of trading.
It’s not just the fancy-sounding names that can be confusing — it’s the underlying concepts and mathematics behind them that can cause even the smartest people to feel like their brain’s melting.
Not only that, but you don’t want a fire-and-forget strategy when you’re an options trader — You need to continually watch and be prepared to manage your positions, and this is where it gets unbelievably complicated.
Many retail investors struggle with the Greeks, and it can take months or even years for them to become proficient in using them in their trading decisions. In other words, being good (not lucky) at options trading is seriously complicated and not for the faint of heart!
If you’re starting to feel a little mind-blown here, don’t worry, we’re about to give your neurons a rest, and show you an alternative to having to learn your Greeks.
Bumper is a DeFi crypto price protection protocol. Rather than making bets on price movement, Bumper allows you to commit your tokens to the protocol using your Web3 wallet (such as Metamask). You simply have two decisions to make — What price level to protect your crypto at, and how long for.
The cost of the protection is based on actual market conditions, and users don’t need to worry about reshuffling their positions to maximize profits. This makes Bumper a simple and fair way to protect the value of your crypto portfolio. There’s no fiddling about with spreadsheets to work out your delta, gamma, theta and vega — just a simple question: do you want to stop losing money when the market crashes?
Options are complicated. Really really complicated — and it’s retail investors who tend to lose big when they play Options markets, according to research conducted at the MIT Sloan School of Management.
In contrast, Bumper allows users to protect the value of their crypto assets without needing to understand complex financial concepts, like those damn Greeks.
Instead, you could just use Bumper set a price level and choose a time period for the protection to last and hey presto, you’re all set — now you can sleep easily, knowing that whatever happens, you’re not going to get the value of your wallet absolutely destroyed if the crypto market decides to take a tumble whilst you’re having a snooze.
Use Bumper, and you too will emerge victorious from the crypto dumps, without the painful head bashing…
Want to know more?
Check out Bumper’s Litepaper, and it’s highly recommended to come and join us in our Discord server where you can ask specific questions and become part of a community that knows all about protection, but doesn’t care much about the Greeks (the concepts, not the people!)
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