A new way to quantify greeks

Written on March 31, 2008 by OptionsRopeaDope

This post is superseded by some tweaks… find the updates here. 

I’ve been thinking about the right way to communicate risk exposure, both for myself, and for the 2 readers of this blog. Raw delats just don’t cut it (although they do help). I tried to do the “10 spreads” trick, but again, that has different meanings for credit spreads, and for debit spreads, and for other variations (such as, distance between long and short strikes, etc, etc, etc). It should definitely be related to the amount of risk you are taking, but that changes over time, and with different market conditions, etc. Is there a better way to understand the true meaning of your greek position on a trade?

After thinking of a few different possibilities, I’m going to start using my own metric, which I’ll call “Risk Reflected” delta, vega, gamma, etc. The difference is, it will be a percentage that takes into account the distance to my max loss from the current position… so, within the limitations of HTML, here is an example -

                                             | Raw Deltas | x 100

RR Delta =     ——————————————————–

                     (current profit or loss) + max loss set at position open

 

And quote as a percent (by the way, the bars are absolute value indicators….). So, let’s say you currently have a loss, and are only $150 away from your max loss… if your deltas are -150, the RR Delta will be 100%, which is quite high. My Max loss is only a 1 point move away! Adjustments are definitely needed!

Alternatively, if you have a $450 profit on the same position, with the same deltas, now the RR Deltas are 25%… a bit nicer. It also tells me I need a 4 point move to reach my max loss.

I’m going to experiment with this, and quote some positions both the way I’m doing now, plus this new way. Might tweak it a little (to reflect the price level of the underlying, and the percentage move required, for example) but I don’t want to overcomplicate things yet. Hopefully I’ll learn a little something here.

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