Option Greeks

Dr. Ajay Kumar Yadav

Parameters of SENSITIVITY
Delta = 
Theta = 
Gamma = 
Vega = 
Rho = 

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Using the following parameters find the value of
Option Greeks for both the put and the call option

• Current Stock Price 100

• Strike Price 100
• Time to maturity (T-t) .50
• Risk free rate 5%
• Volatility 20%
 c = SN(d1) – Ke–r(T – t)N(d2)
p = Ke–r)T –t)N(-d2) – SN(-d1)
Notationally:
c = c(S; K; T-t; r; σ)
p = p(S; K; T-t; r; σ)
Once c and p are calculated, WHAT IF?

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The GREEKS are measures of sensitivity. The question is
how sensitive a position’s value is to changes in any of the
variables that contribute to the position’s market value.
These variables are:
S, K, T, r and .
Each one of the Greek measures indicates the change in the
value of the position as a result of a “small” change in the
corresponding variable.
Formally, the Greeks are partial derivatives.

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 Delta = 
In mathematical terms DELTA is the first derivative of the option’s
premium with respect to S. As such, Delta carries the units of the
option’s price; I.e., Rs. per share.
For a Call: (c) = c/S = N(d1)
For a Put: (p) = p/S
Results: (p) = (c) - 1 = N(d1) - 1
For the (S) = S/S = 1
Delta of the option is also equal to Change in Option premium /
Change in the Underlying value

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 Numerical

Suppose stock XYZ was trading at $520 per share and a call option with a
strike price of $500 was trading for $45. This call option is in-the-money
because the stock price is above the strike price. If the price of XYZ stock
rises to $523, and the value of the call option rises to $46.80, what is the
delta of the option premium.
 GAMMA 
Gamma measures the change in delta when the price of the
underlying asset changes.
Gamma is the second derivative of the option’s price with respect to
the underlying price.
(c) = (c)/S = 2c/ S2
(p) = (p)/S = 2p/ S2
Results: (c) = (p)
(S) = 0.
Formula:

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Numerical

• A stock is currently trading at Rs. 80 and it has options available at

strike price of Rs 75. The premium at this strike price is Rs. 7.50 and it
is going to expire in1 month. The volatility is 30% and the risk-free
rate is 8%. During the period the spot price moves to Rs. 84 what will
be the change in option premium due to this change in spot price.
Gamma as an Indicator of Hedge
Rebalancing
• Gamma is an indicator as the frequency with which delta needs to be
rebalanced.
• When Gamma is closer to zero it means that the Delta will not change
by much to a given change in Spot price.
 THETA 
Theta measures are given by: It indicates the sensitivity
of Options price to time decay
(c) = c/(T-t) (p) = p/(T-t)
s are positive but the they are reported as negative
values. The negative sign only indicates that as time
passes, t increases, time to expiration, T – t, diminishes
and so does the option’s value, ceteris paribus (all other
things being equal). This loss of value is labeled the
option’s “time decay.”
Also, (S) = 0.
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Formula for Theta

•-

′ − 𝒓𝒕 𝟏
−𝑆0 𝜎 𝑵 ( 𝒅 𝟏 ) . −𝒓 𝒆 𝑬 𝑵 ( 𝒅 𝟐)
𝟐√𝒕
 VEGA 
Vega measures the sensitivity of the option’s market price to
“small” changes in the volatility of the underlying asset’s
return.
(c) = c/
(p) = p/
Thus, Vega is in terms of
$/1% change in .
(S) = 0.
Formula:

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 RHO 
Rho measures the sensitivity of the option’s price to “small”
changes in the rate of interest.
(c) = c/r
(p) = p/r
Rho is in terms of $/%change of r.
(S) = 0.
Formula: Te-rt KN(d2) = (c)
-Te-rt KN(-d2) = (p)
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 Example:
S=100; K = 100; r = 8%; T-t =180 days;
 = 30%. Call Put
Premium $10.3044 $6.4360
The Greeks:
Delta =  0.6151 -0.3849
Theta =  -0.03359 -0.01252
Gamma =  0.0181 0.0181
Vega =  .268416 .268416
Rho =  .252515 -.221559
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Again. the Delta of any position measures the
Rs. change/share in the position’s value that
ensues a “small” change in the value of the
underlying.
(c)= 0.6151
(p) = - 0.3849

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 Call Delta
• Delta is the rate of change of the call price
with respect to the underlying

Call price

Slope = D
C
A Stock price 17
 THETA 
Theta measures the sensitivity of the option’s price to a
“small” change in the time remaining to expiration:
(c) = c/(T-t) (p) = p/(T-t)
Theta is given in terms is $/1 year.
(c) = -12.2607/year if time to expiration increases
(decreases) by one year, the call price will increase
(decrease) by $12.2607. Or, 12.2607/365 = 3.35 cent per day.

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 GAMMA 
Gamma measures the change in delta when the
price of the underlying asset changes.
= 0.0181. (c) = .6151; (p) = -.3849.
If the stock price increases to $101:
(c) increases to .6332 (p)
increases to -.3668.

If the stock price decreases to $99:

(c) decreases to .5970
(p) decreases to -.4030.
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 VEGA 
Vega measures the sensitivity of the option’s
market price to “small” changes in the
volatility of the underlying asset’s return.
 = .268416

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 RHO 
Rho measures the sensitivity of the option’s
price to “small changes in the rate of interest.

Rho =  Call Put

.252515 -.221559
Rho is in terms of $/%change of r.

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 DELTA-NEUTRAL POSITIONS
A market maker wrote n(c) calls and wishes to protect the
revenue against possible adverse move of the underlying
asset price. To do so, he/she uses shares of the underlying
asset in a quantity that GUARANTEES
that a small price change will not have any impact on the
call-shares position.
Definition: A portfolio is Delta-neutral if
(portfolio) = 0

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 DELTA neutral position in the simple case of call-stock
portfolios.
Vportfolio = Sn(S) + cn(c;S)
(portfolio) = (S)n(S) + (c)n(c;S)
(portfolio) = 0  n(S) + (c)n(c;S) = 0.
n(S) = - n(c;S)(c).
The call delta is positive. Thus, the negative sign indicates
that the calls and the shares of the underlying asset must be
held in opposite direction.

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 EXAMPLE: call - stock portfolio
We just sold 10 CBOE calls whose delta is $.54/shares. Each
call covers 100 shares.
n(S) = - n(c;S)(c).
(c) = 0.54 and n(c) = -10.
n(c;S) = - 1,000 shares.
n(s) = - [ - 1,000(0.54)] = 540.
The DELTA-neutral position consists of the 10 short calls and
540 long shares.

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 The Hedge Ratio  c
Definition: Hedge ratio.
Hedge Ratio
The number of shares required to neutralize the portfolio

The number of shares covered by the options
In the example:
Hedge ratio = 540/1,000 = .54
Notice that this is nothing other than (c).

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 In the numerical example,:
The hedge ratio: (c) = 0.6151
With 100 CBOE short calls:
n(S) = -(c)n(c;S).
n(c;S) = -10,000.
n(S) = -(.6151)[-10,000] = +6,151 shares The value of this
portfolio is:
V = -10,000($10.3044) + 6,151($100)
V = $512,056
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 Suppose that the stock price rises by $1.
SNEW = 100 + 1 = $101/share.

V= - 10,000($10.3044 + $.6151) +6,151($101)

V = - 10,000($10.3044) + 6,151($100)
- 10,000($.6151) + $1(6,151)

V = $512,056 - $6,151 + $6,151

V = $512,056.

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 Suppose that the stock price falls by $1.
SNEW = 100 - 1 = $99/share.

V= - 10,000($10.3044 - $.6151)
+6,151($99)

V = - 10,000($10.3044) + 6,151($100)
- 10,000( - $.6151) - $1(6,151)

V = $512,056 + $6,151 – $6,151

V = $512,056.
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 In summary:
The portfolio consisting of 100 short calls and 6,151
long shares is

delta- neutral.
Price/share: +$1 -$1
shares +$6,151 -$6,151
calls +(-$6,151) -(-$6,151)
Portfolio $0 $0

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 DELTA neutral position in the simple case of put-stock
portfolios.
Vportfolio = Sn(S) + pn(p;S)
(portfolio) = (S)n(S) + (p)n(p;S)
(portfolio) = 0  n(S) + (p)n(p;S) = 0.
n(S) = - n(p;S)(p)
Since the put delta is negative, then the negative sign
indicates that the puts and the underlying asset must be
held in the same direction.

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 EXAMPLE: put – stock portfolio.
We just bought 10 CBOE puts whose delta is -$.70/share.
Each put covers 100 shares. n(S) = - n(p;S)(p).
(p) = -.70 and n(p) = 10.
n(p;S) = 1,000 shares.
n(S) = - 1,000(-.70) = 700.
The DELTA-neutral position consists of the 10 long puts and
700 long shares.

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Portfolio: The portfolio consisting of 10 long puts and 700
long shares is
delta- neutral.
Price/share: +$1 -$1
shares +$700 -$700
puts -$700 $700
Portfolio $0 $0

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 In the numerical example,
The hedge ratio: (p) = -0.3849
The Delta neutral position with 100 CBOE long puts requires
the holding of:
n(S) = -(p)n(p;S)
n(S) = -(-.3849)[10,000] = +3,849shares The value of this
portfolio is:
V = 10,000($6.4360) + 3,849($100)
V = $449,260.

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 Suppose that the stock price rises by $1.
SNEW = 100 + 1 = $101/share.

V= 10,000($6.4360 - .3849)
+3,849($101)

V = 10,000( $6.4360) – 3,849($100)

- 10,000(.3849) + $1(3,849)

V = $449,260- $3,849 + $3,849

V = $449,260.
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 Suppose that the stock price falls by $1.
SNEW = 100 - 1 = $99/share.

V= 10,000($6.4360 + $.3849)
+3,849($99)

V = 10,000( $6.4360) + 3,849($100)

10,000($.3849) - $1(3,849)

V = $449,260+ $3,849 - $3,849

V = $449,260.
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 In summary:
The portfolio consisting of 100 long puts and 6,151 long
shares is
delta- neutral.
Price/share: +$1 -$1
shares +$3,849 -$3,849
calls +(-$3,849) -(-$3,849)
Portfolio $0 $0

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 Results:
1. The deltas of a call and a put on the same
underlying asset, (with the same time to
expiration and the same exercise price) must
satisfy the following equality:
(p) = (c) - 1
2. Using the Black and Scholes formula:
(c) = N(d1)  0 < (c) < 1
(p) = N(d1) – 1  -1 < (p) < 0

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 The sensitivity of portfolios, a summary.
1. A portfolio is a combination of securities and
options.
2. All the sensitivity measures are partial
derivatives.

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 DYNAMIC DELTA - HEDGING
The market stock price keeps changing all
the time. Thus, a static DELTA- neutral
hedge is not sufficient.
A continuous delta adjustment is not
practical.
An adjusted Delta-neutral Position:
1. Every day, week, etc.
2. Following a given % price change.
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 DYNAMIC DELTA HEDGING
Market makers provide traders with the options
they wish to trade. For example, if a trader
wishes to buy (long) a call, a market maker will
write (short) the call. The difference between
the buy and sell prices is the market maker’s
bid-ask spread.
The main problem for a market maker who shorts
calls is that the premium received, not only
may be lost, but the loss is potentially
unlimited.
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 DYNAMIC DELTA - HEDGING
The Dynamic Delta hedge is based on the
impact of the time decay on the call Delta.
Recall that:
St
ln[ ]  [r  .5σ ][T  t]
2

d1  K
σ Tt
and
N(d1 )  Δ(c) 41
 DYNAMIC DELTA - HEDGING
The Dynamic hedge:
1. Write a call and simultaneously, hedge the call by a
long Delta shares of the underlying asset. As time goes
by, adjust the number of shares periodically.
Result: As the expiration date nears, delta:
goes to 0 in which case you wind
up without any shares.
goes to 1 in which case you call is
fully covered.

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Simulation of Dynamic delta - hedging.
Cost of
Stock Shares shares Cummulative Interest
Week przce Delta purchased purchased cost
cost
($000) ($000)
($000)
0 49.00 0.522 52,200 2,557.8 2,557.8 2.5
1 48.12 0.458 (6,400) (308.0) 2,252.3 2.2
2 47.37 0.400 (5,800) (274.7) 1,979.8 1.9
3 50.25 0.596 19,600 984.9 2,966.6 2.9
4 51.75 0.693 9,700 502.0 3,471.5 3.3
5 53.12 0.774 8,100 430.3 3,905.1 3.8
6 53.00 0.771 (300) (15.9) 3,893.0 3.7
7 51.87 0.706 (6,500) (337.2) 3,559.5 3.4
8 51.38 0.674 (3,200) (164.4) 3,398.5 3.3
9 53.00 0.787 11,300 598.9 4,000.7 3.8
10 49.88 0.550 (23,700) (1,182.2) 2,822.3 2.7
11 48.50 0.413 (13,700) (664.4) 2,160.6 2.1
12 49.88 0.542 12,900 643.5 2,806.2 2.7
13 50.37 0.591 4,900 246.8 3,055.7 2.9
14 52.13 0.768 17,700 922.7 3,981.3 3.8
15 51.88 0.759 (900) (46.7) 3,938.4 3.8
16 52.87 0.865 10,600 560.4 4,502.6 4.3
17 54.87 0.978 11,300 620.0 5,126.9 4.9
18 54.62 0.990 1,200 65.5 5,197.3 5.0
19 55.87 1.000 1,000 55.9 5,258.2 5.1 43
20 57.25 1.000 0 0.0 5,263.3
Mr Ramesh has purchased At-the –money Call option
on R. Com stock with the strike price of Rs100 for Rs.
12.30 and At-the-money Put option for Rs 100 strike
price for Rs. 6.40. The time to expiry of the option is
120 days and volatility is 30% you are required to
calculate;
Delta, Gamma, Theta, Vega and Rho of the Call
option. How will you create a delta neutral portfolio of
Call option and stock if the trader is short on the 20 lot
of call with each lot being 500 stocks. Show how your
portfolio is delta neutral if the price changes by Rs. 3