If you’ve been seeing a lot of tweets and other social media mentioning things like GEX, Vanna, Fixed Strike Vol, and more – but have been left scratching your head a bit to keep all these ‘inside baseball’ terms straight – don’t worry. We’ve equated options trading to an ever-changing three-dimensional chess board with flying sharks shooting laser beams at the players before they eat them, in the past – so know this isn’t as easy as buy this or that stock and hope it goes up.
This is the non-linear world of options where you are betting on multiple dimensions of a derivative’s price, in price, time, and volatility.
We recently went over many of the lesser known option definitions in our podcast Vol Curves and Vanna Charm pod with Cem Karsan, and have pulled the nuggets out of that Cem-gem below, along with some lessons from a favorite @squeezemetrics to give you a chance to understand up from down in the options world:
The Basics:
1. Delta:
Delta represents the change in the price of options relative to the underlying market the option is a derivative of. When you hear option pros say an option has a 10 delta, that means point 10, or .10. So, per one-point move in the underlying stock or index, that would be a 10 cent move in the option price. Delta has to do with Price.
2. Vega:
Vega is the dollar change in options relative to a 1% move in the implied volatility. So, if your option as a $1,000 vega value, and implied volatility goes up 1%, the option goes up in value by $1,000. Vega has to do with Volatility.
3. Theta:
Theta is the decay, so the amount of money that comes out of the option value per day of time. Theta has to do with Time.
4. Skew:
Volatility skew generally refers to the phenomenon that out of the money put options are more expensive (having a higher implied volatility) than equally as far out of the money and with the same expiration data – Call options. This is for many reasons, including the sellers of those options want/need to be paid a premium for the outsize risk, that the market tends to take the ‘escalator up and elevator down’, and institutional demand for portfolio insurance via out of the money puts.
A little more involved:
5. Fixed Strike Vol (per Cem Karsan):
Yeah, so fixed strike vol, a lot of people ask me about this. And it sounds much more complicated than it is. But the reality is, when you look at the implied volatility of an at the money option, in the underlying options for let’s say the SPX, there is an underlying skew. So, if we move down 1% in the market, you’re going to actually naturally slide, the implied volatility of that option that is 1% out of the money is higher than it is here. So that straddle is naturally going to increase as you slide down. That doesn’t mean that implied volatility has increased. If you see the VIX go up on a down move in the market, that does not mean implied volatility has actually increased. Most people don’t understand that people say, Oh, the VIX is going up. The VIX naturally goes higher when the market goes down, based on the skew in the underlying S&P 500. So, what’s important to look at when market makers do, and most sophisticated players do, is they look at fixed strike vol that gives you a real color of our volatility performing relative to the underlying volatility assumptions that the world is pricing. So, if the market moves down 1% and vol is at 50, the question is where are we relative to that 50 vol that we’ve moved to? Not the fact that we were at a 45 vol to begin with, right? So, when you look at fixed strike vol, you’re looking at the strike – by that strike that you’re moving to – how much has that volatility changed? And that’s why I’m always talking in fixed rate vol, that is actually the correct way to objectively look at what’s happening in the implied vol. It’s all relative to the embedded assumptions of the market.
Way more involved (2nd order Greeks relating to Deltas):
Just as Delta, Vega, and Theta were an option’s price sensitivity to price, volatility, and time – the following are used to explain how an option’s Delta will move in relation to changes in price, volatility, and time.
6. Gamma:
This is the change in Delta per change in price, or Delta. A 10 delta option as noted above may become a 20 delta option as the market moves closer to the price, and will eventually become a 100 delta option if through the strike price. Gamma measures how much an option’s deltas change per $1 move in the underlying price. Gamma has to do with Deltas and Price (might have been easier to call them DeltaP or something?)
7. Vanna:
This is the change in Delta per change in implied volatility, or Vega. Here’s Cem: Yeah, so this is one that is not well known….everybody’s always asking me on Twitter, like, where can I read more about this, how the effects of this you know? there are very few number of people who use, even in the market making space, that use Vanna regularly? It is a second order derivative. Vavna is the change in delta per change in Vega, or change in implied volatility. So as implied volatility increases by one, it’s the amount of deltas that change your options position. Vanna has to do with Deltas and Vega, and should maybe have been called DeltaV).
8. Charm:
This is the change in Delta per change in Theta. Here’s Cem again: Another important one that kind of goes hand in hand with Vanna, which I talk a lot about is Charm, a bit more commonly looked at, but still, it’s you know, a second order derivative, that is purchased per change in time. So, per unit of decay, charm is how much your delta changes as well. Charm has to do with Deltas and Theta (so in our new nomenclature would be DeltaT).
9. Volga:
Volga is the change in Vega per an increase in implied volatility. Cem one more time: Yeah, so volga is change, it’s like the gamma vol. So, per change in vol, volga how much Vega you add or subtract. So, it’s essentially the gamma of Vega, kind of like gamma is to delta, volga is to Vega.
Why are all these important, here’s more from the pod with Cem Karsan explaining how these metrics are used:
Both of these are, you’ll notice are our delta focused derivatives. So, the reason I use them so much is these really embody a lot of the Delta effects of the underlying assets. And the broader world looks primarily at the underlying assets. And most of the world is not very familiar with how these derivatives can have a substantial effect, especially now that they’re, you know, the leverage of these products has increased so much over the last 20 years. And so, understanding these Delta based kind of derivatives of the underlying options, is very important to understanding those flows.
People, people look at volga a lot more actually, on the market making side, you know, than they do some of these other effects. I tend to look at it less because it doesn’t have as much of an effect on underlying assets, as much as it has an effect on the underlying volatility of the product. The focus is their focus tends to be on managing implied volatility and the risks associated with implied volatility. They try and tend to be market more market neutral. Again, every shop is different. Whereas my focus, and a lot of people’s focus, is understanding how does this move the underlying product?
Final Stop
Which leads us to the brainiac’s over at Squeezemetrics and their GEX and VEX indices, which measure the Gamma and Vanna for the entire market, thinking that it is probably important to know where all these market maker firms need to re-hedge their ‘deltas’ based off the options they have sold to investors.
10. GEX/VEX:
GEX is simply the net total ‘Gamma Exposure’ and VEX the net total Vanna Exposure. Take a look at their full paper for way more info on these two concepts: https://squeezemetrics.com/download/The_Implied_Order_Book.pdf
