There are several different ways to attempt to predict the movement of option value in relation to the price of the underlying, and many are represented by a letter of the Greek alphabet. Thus, these types of measures are often referred to as the Greeks.
Delta measures price sensitivity by measuring the rate of change between the option's price and the price of the underlying asset. Delta ranges from -1 to 1.
Call options have a positive relationship to the price of the underlying and will approach 1 the further in-the-money the option is. A delta of 0.5 means that if the underlying stock increases by $1, the call option should increase by $0.50.
Conversely, put options have a negative, or inverse, relationship to the price of the underlying and approach -1 the further in-the-money they go. A put option with a delta of -0.6 will increase in value by $0.60 if the underlying security decreases by $1.
Theta measures an option's time sensitivity. It measures the impact of time on the price of the option.
Theta indicates how much the price of your option decreases over a certain period of time, usually expressed over a one-day period. Theta increases as expiration gets closer because the price of the option declines exponentially as expiration approaches. Time is generally expressed as T plus the number of days the option has been in effect. For example, T+0 (the day the position was opened) would have a very low theta, while on day T+13 of a 14-day contract, theta would likely be very high. If theta is, say, 45.75 at T+7, it means that on the seventh day of the contract, the option is losing value at a rate of $45.75 per day.
The following graph shows a general depiction of the way theta increases as the expiration date approaches.
Before tackling implied volatility, it might be helpful to brush up on the concept of historical volatility as it relates to investing. Volatility measures how much and how quickly the value of a security or market sector changes.
Implied volatility, on the other hand, is a more complex measurement that is used in the options pricing model. It combines historical volatility, current market conditions, and future expectations for a particular stock to estimate future price volatility. Generally, implied volatility responds to public perceptions of the market and typically increases in bearish markets (sometimes considered more risky) and decreases in bullish markets (considered less risky).
Examples exclude transaction costs and tax considerations.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (available at your local Scottrade branch office or from the Options Clearing Corporation at 1-888-OPTIONS or by visiting www.888options.com). All option accounts require prior approval by Scottrade. Market volatility, volume, and system availability may impact account access and trade execution. Supporting documentation for any claims will be supplied upon request.