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Option Greeks II.

More Greeks, deeper insights.

Use Greeks to manage time decay, volatility, and rates.

Introduction to Theta, Vega, and Rho 

Option Greeks measure how different factors affect an option's price. 

After learning about delta and gamma, Delilah wants to understand how time decay, volatility, and interest rates influence her options. 

Theta represents time decay, vega measures sensitivity to volatility changes, and rho gauges the impact of interest rate fluctuations. 

By grasping these concepts, she can better predict option price movements and refine her trading strategies to manage associated risks.

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Understanding Theta (Time Decay) 

Theta quantifies the rate at which an option's value decreases over time, known as time decay. 

It indicates how much the option's price will decline each day if all other factors remain constant. 

As expiration approaches, there's less time for the underlying asset to move favorably, causing options to lose value. 

Theta is usually negative for option holders, meaning they lose value over time, and is highest for at-the-money options with short time to expiration.

Delilah Considers Theta  

Holding a call option on GlobalTech Corp. with a theta of -0.05, Delilah realizes her option loses $5 in value daily (-$0.05 × 100 shares) due to time decay. 

With ten days until expiration and the stock price stagnant, she's facing a $50 erosion purely from time passing. 

Aware of this, she decides to either sell the option now to preserve value or adjust her position, perhaps by rolling into a longer-term option to mitigate the effects of theta.

 Strategies Involving Theta 

Traders can use theta to their advantage by selling options and collecting premiums, benefiting from time decay. 

Option writers, especially in strategies like covered calls or short straddles, profit as options lose value over time. 

Conversely, buyers need to be mindful of theta's impact, as holding options without significant price movement can lead to losses. 

Timing becomes crucial; selecting options with appropriate expiration dates can help mitigate adverse effects of time decay.

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Understanding Vega 

Vega measures an option's sensitivity to changes in the underlying asset's volatility. 

It indicates how much the option's price will change for a 1% change in implied volatility. 

Higher volatility increases the likelihood of the option ending in-the-money, thus raising its premium. 

Options with longer time to expiration and those at-the-money have higher vega. 

Understanding vega helps traders anticipate how fluctuations in market volatility affect option pricing.

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