Deeper into Greeks

Nifty slipped below 200 DMA and is right at the zone where there is maximum Put build up, 10,000 strike. With ~ 52 lakh shares of open interest, this is by far the largest position among Put strikes. This would partly be the reason why Nifty drifted around 10k levels on Friday, inspite of sharp correction in other markets.

Such times one needs to look beyond the screen and try to improve his/her skills. For an option trader, honing of skills can be either working of the strategies or understanding the positions better. To understand one’s position, it is important to understand the Greeks better. The Greeks, which we have been following till date, are the first order Greeks: Delta, Vega, Theta and Rho. Sometimes one looks at Lambda and Epsilon.

Lambda is the percentage change in option price; due to percentage change in underlying price. Lambda is the leverage or the gearing ratio, which one calculates on hindsight.

Epsilon is the percentage change in option value due to change in dividend yield of the underlying. Epsilon, is not used extensively, because it has limited utility in terms of the dividend yield, which is not so closely monitored.

However, all our calculations continue to stay around the first order Greeks. We generally do not look at second order or third order Greeks. Undoubtedly, in a normal market scenario we need not look at it. Our energies should focus on stock picking and strategy building. However, the current market scenario demands extra effort. That comes from effectively understanding intra Greek relations. That in turn comes from understanding the second and third order Greeks.

Let us quickly look at a few second order Greeks:

Gamma:  measures the rate of change in the delta with respect to changes in the underlying price.
Vanna: measures the sensitivity of the option Delta with respect to change in volatility.

Charm: measures the rate of change of Delta over the passage of time.

Vomma: measures the rate of change of Vega as volatility changes.

Veta: measures the rate of change in the Vega with respect to the passage of time.

Surely one can dig further and look at third order aswell, which include

Speed: measures the rate of change in Gamma with respect to changes in the underlying price.

Zomma: measures the rate of change of Gamma with respect to changes in volatility.

Color: measures the rate of change of Gamma over the passage of time.

So, clearly there is a sharp connection among each of the Greeks. Thus, it makes lot sense to look beyond the stand-alone Greeks and understand their impact on each other. While the third order Greeks may not be that important, it is extremely important to understand the second order Greeks as they tell you so much about the correlation among the Greeks. This gives a clear picture for an effective option strategy.

Happy Trading

Cheers!!