Market Overview

A Lot Of Theta And A Little Rho

Theta is the measure of how much money an option position makes or loses a day in time decay. A positive Theta is the money made and a negative Theta is the money lost.

In individual options Theta measures how much the price will decrease with an unchanged stock price and a stable implied volatility simply through time decay. So, an option trading at 2 with a Theta of .05 should be worth 1.90 in 2 day's time if the stock and implied volatility is unchanged. Long term options have a low Theta as they lose very little on a daily basis whereas Theta greatly increases as expiration approaches. At the money options also have the highest relative Theta.

As you can imagine, being long option premium creates a negative Theta while being short premium creates a negative Theta. In this way, looking back at yesterday's discussion, a positive Gamma almost always comes with a negative Theta and vice versa.

I will conclude my discussion of the Greeks with Rho, which is a measure of how an option or an entire option position is affected by a change in interest rates. In this era of near zero real interest rates Rho is not really relevant but in years past it was.

Rho measures how much the value of an option changes for each 1.00% move in interest rates.

Assume a 50 call trading at 2 with interest rates at 5%. With the Rho of the option at .02 the call should rise to 2.02 if interest rates move to 6% and be worth 1.98 if interest rates fall to 4%.

Rho is most relevant for professional traders who carry or are short a lot of a high priced stock. At today's price 10,000 shares of Google represents $5,137,150, after all.
That concludes my discussion of the Greeks
. As I've said, not really relevant for the home trader but I hope just the same you found it of interest and edification.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

Posted-In: Education General


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