Intermediate Options Strategy With Ally Invest's Brian Overby

Attendees at Benzinga's virtual Boot Camp Friday got a lesson in intermediate options Friday from  Brian Overby, a senior options analyst at Ally Financial Inc.'s ALLY Ally Invest and the author of the "The Options Playbook."

Know The Greeks

Overby quickly overviewed the four "Greeks" that investors and traders need to understand when pricing an option. They are:

1. Delta (Δ): The amount an option's price will change for a corresponding one-unit (point) change in the price of the underlying stock.

2. Gamma (Γ): The amount an option's delta will change for a corresponding one-unit (point) change in the price of the underlying stock.

3. Theta (Θ): The amount an option's price will change for a corresponding one-unit (day) change in the days to the expiration of the option contract.

4. Vega (ν): The amount an option's price will change for a corresponding one-unit (percent) change in implied volatility.

All of the Greek symbol values are theoretical in nature but the "best guess we can have as to how our option price will react," he said.

Delta: Non-Textbook Definition

After reviewing a "textbook definition" of what a delta means, Overby said it is just as important to understand the more practical "non-textbook definition": "the delta is the probability of the option being in the money on expiration."

It should be noted that this contrasts from the probability of "making money." After all, if an option contract closes 1 cent in the money, an investor could still be sitting on a loss, as the price of the contract was more than 1 cent.

Suppose a stock is trading at $50 and an investor owns a call option with a $50 strike.

If there is one day left to expiration, the delta on the contract would (hypothetically) be 0.50. But if the stock rises to $51 with hours left before expiration, the delta could soar as high as 0.90.

Suppose there are 60 days left to expiration and the delta on the contract is the same 0.50. If the stock rises from $50 to $51 the delta could rise to, say, 0.60.

Gamma, A Derivative Of Delta

Gamma is in fact a derivative of the delta, as it is derived from the options price, Overby said. Gamma will always be highest for the near-term at the money strike and slopes off toward the in-the-money and out-of-the-money strikes, he said. 

"If you are trading options, no matter what your strategy is, you need to think about how time to expiration and delta is going to change on your option contract."

Theta: Time Decay

The time decay measures the rate of decline in the value of an options contract and will accelerate as the option approaches the expiry date. This is due to the fact that the stock has less time to hit the desired strike price, Overby said. 

Vega: Implied Volatility

Although not a Greek letter, vega measures the amount an option price will change for a corresponding one-point change in implied volatility, the options analyst said. Vega itself will only impact the time value of an option's price, he said. 

As implied volatility rises, so does the value of an option contract. The logic behind this is that higher volatility implies more erratic movements in the stock.

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