Binary Options Greeks refer to the set of variables derived from the Black-Scholes model (BSM) used to calculate the theoretical price of options contracts. These Greeks, represented by Greek alphabets, measure the sensitivity of an option’s price to changes in various factors including the price of the underlying asset, interest rates, volatility, and time decay. They are essential for dynamic portfolio management in binary options.
Binary Options Greeks in a nutshell
- Variables derived from the Black-Scholes model for option pricing.
- They measure an option’s sensitivity to changes in underlying asset, volatility, time, and interest rates.
- Key Greeks include Delta, Gamma, Theta, Vega, and Rho.
How many Binary Options Greeks exist?
There are five binary options greeks called Delta, Gamma, Theta, Vega, and Rho.
Delta (δ)
Delta measures an option’s sensitivity to changes in the underlying asset’s price. It describes the change in the option price for a price change of $1 for an asset. With binary options, the delta can rise to infinity before expiry, which can lead to large profits. For binary calls, Delta is always positive, while for puts, it’s consistently negative.
Gamma (γ)
Gamma quantifies the rate of change of Delta with a $1 shift in asset price. Options with high gamma respond rapidly to changes in the underlying asset’s value. This becomes crucial in predicting Delta’s future movements, especially for binary options nearing their target price. The gamma decreases as the options move towards profitability.
Theta (θ)
Theta reflects time decay, showcasing how much an option’s price decreases with each day closer to expiry.
Vega
Vega measures the impact of changes in implied volatility on option prices. Higher volatility typically increases option values, but for binary options traders, excessive Vega might pose risks, turning profitable trades into losses at expiry.
Rho (ρ)
Rho represents the influence of interest rate fluctuations on option prices. In binary options trading, the importance of Rho becomes less important due to short-term expiry dates.
What role do Binary Options Greeks play in risk management?
Based on my experience, the Greeks play a critical role in managing risk for binary options trading by helping traders understand their risk profiles and make informed decisions. The binary options Greeks covered are:
| Binary Options Greeks | Below Strike | Above Strike |
|---|---|---|
| Binary Call Option Delta | +ve | +ve |
| Binary Put Option Delta | -ve | -ve |
| Binary Call Option Gamma | -ve | +ve |
| Binary Put Option Gamma | +ve | -ve |
| Binary Call Option Theta | +ve | -ve |
| Binary Put Option Theta | -ve | +ve |
| Binary Call Option Vega | +ve | -ve |
| Binary Put Option Vega | -ve | +ve |
These were the Greeks that worried me in the pits and then in front of the (mentally grueling) screens during my 15 years as an options market maker, with Greeks like Rho being of minor importance even when trading STIRs.
Any person can appreciate the fair value and create a two-sided market around it, but the risk management that follows trading separates the professionals from the amateurs.
Many do not understand their Greeks well enough to put on a complicated show and understand how their Greek profiles have evolved. A trader’s confidence in pricing is inevitably affected by his inability to understand his risk profile. For example, an options trader who does not know his delta would be comparable to a futures trader who does not know how many futures he is long or short.
I have been asked countless times what lessons I have taught an options trader who wanted to start trading. The truth is that I have never taught anyone how to trade because I was too busy showing them how to avoid losing money.
