Understanding Option Greeks and Dividends: An Introduction
In the options marketplace, the “Greeks” have zero to do with classic philosophers or toga parties (unless you’re trading from the fraternity house). For option traders, the Greeks are a series of handy variables that help explain the various factors driving movement in options prices (also known as “premiums”).
Many options traders mistakenly assume that price movement in the underlying stock or security is the only factor driving changes in the option’s price. In fact, it’s very possible to watch the option contract move up or down in value, while the underlying price stays still.
There are many factors that affect an option’s price, and the Greeks help us understand this process better. It’s possible for some Greeks to be working for your position while others are simultaneously working against it. If you understand how changing conditions can affect your options trades, you may be able to better position yourself accordingly.
Mathematically speaking, the Greeks are all derived from an options pricing model. The best known is Black-Scholes, but many variations are used. For equity options, it is most common to use some form of the Cox-Ross-Rubinstein model, which accounts for the possible early exercise of American-style options.
Each Greek isolates a variable that can drive options price movement, providing insight on how the option’s premium will be affected if that variable changes.
We’ve created articles that address each of the major Greeks: delta, gamma, theta, vega, and rho, as well as dividends. Read the articles to learn more about the Greeks in terms of their importance and how to use them in your trading decisions.