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Number of messages : 22
Points : 1618
Date of Entry : 2015-07-30
Year : 54

ma1 Measuring risk, ‘The Greeks’ made easy !

on Thu Jul 30, 2015 8:04 pm
The Greeks are mostly for advanced option traders. They are quantities representing the sensitivities in the premium of an option. They are used to forecast the risk attached in an option contract over time.
A combination of Greeks may help forecast the outcome of an option.

Delta or Hedge Ratio
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Measures the changes in the premium (P) of an option with respect to changes in the price (S) of the underlying currency pair. Delta can be expressed as a percentage or in money terms, and can be seen as the likelihood of an option expiring in the money. A delta of 50% is when the option is at the money (ATM). An option is more likely to expire in the money if its Delta is greater than 50% and less likely when Delta is lower than 50%. Delta is positive for long calls and short puts while it is negative for short calls and long puts.

Gamma
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Measures the changes in the rate of Delta (Δ) with respect to changes in the price (S) of the underlying currency pair. The question here is: by how much will Delta change following a change in the spot price? Generally all long options have positive Gamma whereas all short options will have negative Gamma.

Vega
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Measures how the premium (P) of the underlying currency pair will be affected by
changes in volatility (σ). It is expressed as the amount of money the option will gain or lose as volatility
rises or falls by 1%. Vega is important especially in volatile markets and therefore can monitor the
premium of an option.

Theta
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Measures the sensitivity of the premium (P) of an option to the passage of time (τ), “time decay”. Time decay accelerates as the option nears the expiration date. Theta is negative for long calls and puts and positive for short calls and puts.

Rho
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Measures the sensitivity of the premium (P) of an option to changes in interest rates (r).

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