Greek exposure - calculations

Written on May 13, 2008 by OptionsRopeaDope

After spending time with my past greek calculations I spotted some weaknesses and decided to tweak them… the results are below. 

Tracking greeks have one benefit - the reveal just how exposed you are to risk for any single option strategy, and how “healthy” your position is, and whether you can expect it to produce income or not. Dealing with raw deltas alone don’t give enough information.. as an example, right now I have one posittion (a double diagonal), with a delta of -2… and another (a double calendar) with a delta of -79. Which one is healthier? Let’s say I have the same investment in , as if i had 10x invested in one over the other, that would matter… then which one?

You still wouldn’t know… because the -2 could be on the NDX… while the -79 could be QQQQ. (hint… the NDX trade actually has the higher delta exposure…) My point is, the raw greeks don’t tell you the whole story - and that story is, just how exposed am I to a loss? This really becomes important to know as you scale your trades up… if -50 made you feel queasy a year ago, and now you’re dealing with -1000 deltas because you’re trading your home equity line, without some perspective your brain will have alot of trouble dealing with all of the variables flying around. Not good. So I thought I’d come up with a few “scores” that would shed alot more light on.

I found that the key is knowing, and using, the 1 day standard deviation of the underlying, and comparing it to the greeks, and comparing that to how close you are to your max loss. Why the max loss? Because, I don’t ever want to be there dude. Stay away. Far ahead of time, I want to adjust myself out of there. So here are the calcs I’ll use in the future - first, the ”Risk Reflected” delta -

                                              Raw Deltas  x (1 day std dev move) x 100

RR Delta =     ————————————————————————

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

To get the 1 day std dev move, you multiply the current price of the underlying, by the current IV of the ATM call, by .0523. (.0523 is the square root of 1/365…). The underlying SHOULD move that much once or twice a week, on average…. That probably deserves a seperate post….

So doing that for Delta and Gamma will give you a number you can do something with. For RRVega, drop the 1 day std dev… as it doesn’t reflect price of the underlying but of the option itself. What would the numbers tell me? a score of 20% for RRDelta tells me the underlying needs to move 5 standard deviations to reach my max loss…. pretty comfortable. a score of 75% means it’s a little sick… time for an adjustment! RRVega of 33% tells me a drop of 3 points in IV will butcher my position badly. So if that seems like it might happen, I should probably not be surprised and be prepared to do something about it.

One more calculation is needed to tell me that I’m in good shape with my whole reason for opening the trade in the first place - theta. So for that, how much movement will wipe out my theta gain for the day?

Raw deltas*(1 day std dev move)/theta

This give me a score… ideally, Id like this to be less that 1… the closer to .1 or .2 the better. If it is high, say 5 or more, Im in alot of risk to getting into a hole if the underlying moves in one direction strongly. (on the other hand, i’d make a ton if it moved the other direction… but that’s not the game I want to be in).

So there you go… I’ll use these in future posts to update my trade positions.

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