When trading options, a trader is constantly faced with the choice between the gamma and theta. In simple words, if a trader has bought options, the gamma will be positive and the price for positive gamma will be theta. Conversely, if a trader has sold options, the trader will receive theta for negative gamma.
Trader can buy or sell the underlying asset in order to hedge delta of an option position. Now we will analyze the principle of delta hedging in more detail and show an example of gamma hedging.
Theta measures the sensitivity of an option's price to changes in time, all other parameters being equal. Theta usually has a negative value if the trader owns options, and a positive value if the trader has a short option position. Figure 1 illustrates how the call option price changes as the time passes.
Γ = δΔ<
Δ = δV/δS
ρ = δV/
Often, non-professional options traders have a lot of confusion regarding the relationship of vega and implied volatility. This becomes obvious when traders use phrases: “long vega”, “long implied volatility” or simply “long vol”. So, what is the connection between an option position vega and implied volatility?
It is very difficult to predict what will happen to the price of an option or a position with several options, because market changes can be unexpected. Since the price of an option does not always change according to the price of the underlying asset, it is important to understand what factors affect the price of the option.
υ = δV/