Delta measures an option's value concerning the underlying asset, indicating whether the option will expire in, out, or at the money.
In a call option (an option to buy), Delta ranges from 0 to 1, while in a put option (an option to sell), it ranges from -1 to 0.
Suppose you contemplate buying an option to purchase US Dollars in exchange for British Pounds at a rate of 1.20. With a Delta of 0.75, the option is in the money, suggesting a more favorable rate than the open market.
On the other hand, a Delta of 0.5 signifies the option is at the money, where market and option rates align. A Delta close to 0 indicates an out-of-the-money option, where the open market offers a better rate.
Gamma represents the speed of Delta's change over time in an option.
Gamma is typically highest when an option is at the money, as small fluctuations significantly impact the option's value. Conversely, in-the-money and out-of-the-money options have low Gamma because their value remains stable unless unforeseen events occur.
In the previous example, if the exchange rate is at 1.20, a minor 0.1 fluctuation can affect the option's status. Thus, Gamma will be high. However, if the market rate is 1.05, low Gamma results from the stability of both currencies.
Vega gauges an option's sensitivity to volatility, reflecting the rate of underlying asset fluctuations. Options function like insurance, more valuable in high volatility scenarios, as unexpected extremes are more likely, necessitating option exercise.
In contrast, low volatility implies a decreased chance of unforeseen changes and, consequently, reduced option value.
Theta reflects an option's price decay over time, tied to its in, out, or at-the-money status. At- and out-of-the-money options experience increased Theta as expiration nears due to their unlikely in-the-money outcome.
In-the-money options display lower Theta as they remain profitable up to expiration, barring significant unexpected events.
Rho assesses an option's price sensitivity to interest rate shifts. Interest rate fluctuations are less frequent and impactful than underlying asset volatility, causing Rho to increase for options with longer expiration dates, while it approaches zero as options near expiration.