Greeks and Greek Ratios

Using Greeks and Greek Ratios To Enhance
Your Trading Returns

www.optionstradingiq.com
© Copyright 2017. Options Trading IQ. All Rights reserved.
1
SESSION 1 - RECAP
Step 1: Avoiding the 2 Biggest Mistakes
Step 2: Using Probabilities in Your Favor
Step 3: Volatility Is Your Edge
Step 4: Study Some Greek
Step 5: Strategy Selection

2
OUTLINE
Delta
Gamma
Vega
Theta
Rho
Greek Ratios

3
MY TRADING
Best Monthly Return +9.13%. Dec 2012
Worst Monthly Return -8.09%. July 2013
31.82% in 4 months Dec 2012 – Mar 2013
Scaled Back Risk Since July 2013

4
THE BAD – GOOG SEPT 2012
Too Stubborn
Stock Moved Much Further Than I Thought Possible
Couldn’t Continue To Hold While Losses Mounted

5
THE UGLY – NDX JULY 2013
Took On Way Too Much Risk
Delta $ Exposure - $350,000 $1,500,000
Vacations

7
Delta
Delta: Delta is the option's sensitivity to changes in the underlying
stock price. It measures the expected price change of the option
given a $1 change in the underlying.

9
Delta
Calls have a delta between 0 and 1
Puts have a delta between 0 and -1
Delta can be used as a “rough” probability

10
Delta
As an option goes further in the money, the likelihood that it will
expire in the money increases. Therefore, the delta increases.
Let’s look as an example:

11
Delta
As expiration approaches, the stock will have less chance to move above or
below the strike price.
In-the-money options will rapidly approach 1 (calls) and -1 (puts) as

expiration approaches.
Out-of-the money options will rapidly approach 0 as expiration approaches

13
Gamma
Gamma: The gamma metric is the sensitivity of the delta to
changes in price of the underlying asset. Gamma measures the
change in the delta for a $1 change in the underlying.
Gamma is delta’s ugly cousin. Not many beginners pay attention to

gamma, and it can do serious damage to a portfolio

14
Gamma
If delta is the “speed” at which option prices change, you can think
of gamma as the “acceleration.”
Options with the highest gamma are the most responsive to

changes in the price of the underlying stock.
High Gamma = Big changes in P&L!

15
Gamma
High gamma can be a good thing or a bad thing.
Positive gamma is good if you get a big move (gains accelerate

exponentially).
Negative gamma is bad if you get a big move (losses accelerate

exponentially).
Some may have experienced this with condors that start moving
against you.

16
Gamma
Gamma is highest close to expiry. You may have noticed this if you
have traded weekly options.
They call the last week of an options life “gamma week”.
Options have a very high price sensitivity when gamma is high.

17
Gamma

18
Gamma Scalping
Gamma Scalping is a technique used by market makers and other
professional traders.
I’ll go in to this strategy in more detail later.
Gamma scalping requires traders to be well capitalized.
Traders also need to have a very good understanding of how option

greeks work before undertaking this strategy.

19
Vega
Vega: Vega is the option's sensitivity to changes in implied volatility.
A rise in implied volatility means a rise in option premiums, and so
will increase the value of long calls and long puts. Vega increases
with each expiration further out in time.

20
Vega
Typically, as implied volatility increases, the value of options will
increase. That’s because an increase in implied volatility suggests
an increased range of potential movement for the stock.
Here is a theoretical example to demonstrate the idea. Let’s look at
a stock priced at 50. Consider a 6-month call option with a strike
price of 50:
If the implied volatility is 90, the option price is $12.50


21
Rho
Rho is the amount an option will change based on a one percentage
point change in interest rates.
Most traders ignore Rho. If you’re trading short-term options,

changes in interest rates will not have much of an impact.
The only options that tend to be materially impacted by interest

rates are LEAPs due to the change in the “cost of carry”.

22
Greek Ratios
There is no single best way to trade options. Neither is there a best
way to manage the greeks.
The important thing to understand is the WHY we should pay

attention to Greek Ratios and why we set certain guidelines in terms
of Greek Ratios.
Another point to emphasize is not to get too hung up on specific

Greek Ratios. There usually has to be some level of judgement
used but knowing some key ratios will help you know when to adjust
and help avoid large losses.

23
Delta / Theta Ratio
The Delta / Theta ratio is the most important Greek Ratio. It is
literally the position Delta divided by Theta.
With options income trading, we are aiming to maximize Theta. We

want time decay working in our favor.
If we want Theta to be the major driver in the trade, then we want

Delta to be very low in proportion to Theta.
A high Delta / Theta ratio means price is the major factor in the trade
rather than Theta.

24
Delta / Theta Ratio
Greek Ratio guidelines will be different depending on the strategy
and instrument traded.
For a typical RUT Iron Condor, you want adjust when the Delta /
Theta Ratio gets to around 30%.
Again this is not a hard rule. Just know, that if you don’t adjust and
the position continues to move against you, losses can accumulate
very quickly.

25
Delta / Theta Ratio
Looking at this position, you can see that the condor is no longer
Delta Neutral as the market has moved up.
The Delta / Theta Ratio is 33%. Calculated as 38 / 115 = 33%
You could leave the position as is, but if the market rallies 1-2%, the
position will start to be in real trouble.

26
Delta / Theta Ratio
There are many, many adjustment techniques which I will go over in
more detail shortly, but here is one possible scenario.
Close half of the contracts on the under pressure side.
The profit potential on the trade has been lowered, but our Delta /
Theta ratio is back to 10% and the trade is much safer now.

27
Delta Dollars
Before I move on to the Vega / Theta ratio I want to talk a bit about
Delta Dollars.
Delta Dollars is calculated as Position Delta x Underlying Price.
E.g. -38 x 1251.65 = roughly -47,391

28
Delta Dollars
Delta Dollars can tell you roughly how much a position can gain or lose
depending on how much price moves. It’s not an exact science because of
our old friend gamma, but this is the rough calculation.
Price move in percentage x Delta Dollars
E.g. for this position, if price moves up 1%, the position will lose:
1% x $47,391 = $473.91

29
Delta Dollars
Similarly, if price moves down 1% the position will gain $473.91
If price moves up 2% the position will lose:
2% x -$47,391 = -$947.82
In actual fact the loss will be larger thanks to gamma as losses will
accelerate as the position moves against us.
Note: this calculation assumes no change in volatility, time to expiry or any

other variable other than price.

30
Delta Dollars
Again, I’ll go over Delta Dollars in much more detail, but for now, start to be
aware of this metric.
Rules can be developed to ensure your Delta Dollar exposure doesn’t get
too large.
For example, I like to keep my Delta Dollar exposure less than 150% of my
capital balance.
E.g. If your capital balance is $50,000, don’t let Delta Dollars get above plus
or minus $75,000.
This will help you avoid blowing up your account.

31
Vega / Theta Ratio
The Vega / Theta ratio is another important metric to keep an eye
on.
When the ratio gets too high, volatility will have a big impact on your
position.
We want Theta to be the major driver of our trades and portfolio.
If you have a lot of short Vega trades, like iron condors, your Vega /
Theta ratio can be quite high.
Adding some long Vega trades can help bring the ratio back in to
line.

32
Vega / Theta Ratio
A good rule of thumb is to keep the Vega / Theta Ratio to less than
400%.
This will vary depending on the strategy, instrument and time to
expiry.
In our condor example, the Vega / Theta ratio was 257% which is
ok.

33
Vega / Theta Ratio
Vega exposure increases as you go further out in time. Theta also
decreases.
Therefore, longer term trades will have a much different Vega /
Theta ratio.
For example, this 60 day iron condor has a Vega / Theta ratio of
571%.

34
Vega / Theta Ratio
This 1 week iron condor has a much different ratio again.
Delta / Theta ratio is 13%.
Vega / Theta ratio is 68%
Both with in acceptable boundaries, but don’t be fooled, this is a
very risky trade!
Look at Gamma at -11.

35
Different Underlyings = Different Rules
The ratios we have looked at so far were all for positions in RUT.
But, the ratios will be different for different underlying instruments.
Look at this trade in GLD for example:
Delta / Theta = 270%
Vega / Theta = 2187%

36
Different Underlyings = Different Rules
Get to know each underlying instrument that you trade and you will
soon learn the ratios for each.
Also, keep an eye on Delta Dollars, you can use this to standardize
your Delta exposure.

37
Overall Portfolio
As well as looking at the Greeks and Greek Ratios on individual
positions, we can also look at them on the overall portfolio.
For example, let’s assume we have a number of positions open in
RUT in various expiration dates.
We determine that our Delta Dollar exposure and Delta / Theta
Ratio is too high. We could adjust some of the existing position, OR
we could layer in another position that helps bring our exposure
down.

38
Overall Portfolio
Adding an SPX bull put spread, helps bring our Delta Dollar
exposure back close to zero and our Greek Ratios are looking much
better.
Before Adjustment
After Adjustment
NEXT SESSION – MY TWO FAVS
Weekly Diagonal Spread Trading Plan
Weekly Diagonal Examples
Bearish Butterfly Trading Plan
Bearish Butterfly Examples

40
THANK YOU!
www.optionstradingiq.com

41

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Using Greeks and Greek Ratios To Enhance

Your Trading Returns

Step 2: Using Probabilities in Your Favor

Step 3: Volatility Is Your Edge

Step 4: Study Some Greek

Step 5: Strategy Selection

© Copyright 2017. Options Trading IQ. All Rights reserved.

© Copyright 2017. Options Trading IQ. All Rights reserved.

Best Monthly Return +9.13%. Dec 2012

Worst Monthly Return -8.09%. July 2013

31.82% in 4 months Dec 2012 – Mar 2013

Scaled Back Risk Since July 2013

© Copyright 2016. Options Trading IQ. All Rights reserved.

Stock Moved Much Further Than I Thought Possible

Couldn’t Continue To Hold While Losses Mounted

© Copyright 2016. Options Trading IQ. All Rights reserved.

Took On Way Too Much Risk

Delta $ Exposure - $350,000 $1,500,000

© Copyright 2016. Options Trading IQ. All Rights reserved.

© Copyright 2017. Options Trading IQ. All Rights reserved.

Calls have a delta between 0 and 1

Puts have a delta between 0 and -1

Delta can be used as a “rough” probability

© Copyright 2017. Options Trading IQ. All Rights reserved.

Let’s look as an example:

© Copyright 2017. Options Trading IQ. All Rights reserved.

In-the-money options will rapidly approach 1 (calls) and -1 (puts) as

Out-of-the money options will rapidly approach 0 as expiration approaches

© Copyright 2017. Options Trading IQ. All Rights reserved.

Gamma is delta’s ugly cousin. Not many beginners pay attention to

© Copyright 2017. Options Trading IQ. All Rights reserved.

Options with the highest gamma are the most responsive to

High Gamma = Big changes in P&L!

© Copyright 2017. Options Trading IQ. All Rights reserved.

Positive gamma is good if you get a big move (gains accelerate

Negative gamma is bad if you get a big move (losses accelerate

© Copyright 2017. Options Trading IQ. All Rights reserved.

They call the last week of an options life “gamma week”.

Options have a very high price sensitivity when gamma is high.

© Copyright 2017. Options Trading IQ. All Rights reserved.

© Copyright 2017. Options Trading IQ. All Rights reserved.

I’ll go in to this strategy in more detail later.

Gamma scalping requires traders to be well capitalized.

Traders also need to have a very good understanding of how option

© Copyright 2017. Options Trading IQ. All Rights reserved.

© Copyright 2017. Options Trading IQ. All Rights reserved.

If the implied volatility is 90, the option price is $12.50

© Copyright 2017. Options Trading IQ. All Rights reserved.

Most traders ignore Rho. If you’re trading short-term options,

The only options that tend to be materially impacted by interest

© Copyright 2017. Options Trading IQ. All Rights reserved.

The important thing to understand is the WHY we should pay

Another point to emphasize is not to get too hung up on specific

© Copyright 2017. Options Trading IQ. All Rights reserved.

With options income trading, we are aiming to maximize Theta. We

If we want Theta to be the major driver in the trade, then we want

© Copyright 2017. Options Trading IQ. All Rights reserved.

© Copyright 2017. Options Trading IQ. All Rights reserved.

The Delta / Theta Ratio is 33%. Calculated as 38 / 115 = 33%

© Copyright 2017. Options Trading IQ. All Rights reserved.