Prof. Pankaj K.

Gupta
Delta
Delta is the change in option premium expected from a
small change in the stock price. Delta is a measure of option
sensitivity.
Delta indicates the number of shares required to hedge
against a position in an option.
 Delta
 For a call option:

C
 For a put option: c 
S

P
p 
S
Computing Delta

 rt
  e N (d 2 )
 Measure of Option Sensitivity
 For a European option, the absolute values of the put and
call deltas will sum to one.

 For Black & Scholes Model, the call delta is exactly equal to
N(d1)
 Measure of Option Sensitivity
 The delta of an at-the-money option declines linearly over
time and approaches 0.50 at expiration
 The delta of an out-of-the-money option approaches zero as
time passes
 The delta of an in-the-money option approaches 1.0 as time
passes
Theta
Theta is a measure of the sensitivity of a call option to the
time remaining until expiration:

C
c 
t

P
p 
t
Theta (cont’d)
For European calls and puts, theta is:
SN (d1 )  r (T  t )
c    rf Xe N (d 2 )
2 T t
x2
1 
where N ( x)  e 2
2
SN (d1 )  r (T  t )
p    rf Xe N (d 2 )
2 T t
 Theta (cont’d)
 Theta is greater than zero because more time until
expiration means more option value

 Because time until expiration can only get shorter, option

traders usually think of theta as a negative number
 Theta (cont’d)
 The passage of time hurts the option holder

 The passage of time benefits the option writer

 Gamma
 Gamma is the second derivative of the option premium with
respect to the stock price
 Gamma is the first derivative of delta with respect to the
stock price
 Gamma is also called curvature
Gamma (cont’d)

 2C  c
c  2 
S S

 2 P  p
p  2 
S S
Gamma (cont’d)

For calls and puts, gamma is:

N (d1 )
c   p 
S T  t
 Gamma (cont’d)
 As calls become further in-the-money, they act increasingly
like the stock itself
 For out-of-the-money options, option prices are much less
sensitive to changes in the underlying stock

 An option’s delta changes as the stock price changes

Gamma (cont’d)
 Gamma is a measure of how often option portfolios
need to be adjusted as stock prices change and time
passes
 Options with gammas near zero have deltas that are not
particularly sensitive to changes in the stock price
 For a given striking price and expiration, the call
gamma equals the put gamma
Sign Relationships

Delta Theta Gamm

a
Long call + - +
Long put - - +
Short call - + -
Short put + + -

The sign of gamma is always opposite to the sign of theta

 Vega
 Vega is the first partial derivative of the BS Model with
respect to the volatility of the underlying asset:

C
vega c 


P
vega c 

Vega (cont’d)

  S T  t N (d1 )
Vega (cont’d)
 All long options have positive vegas
 The higher the volatility, the higher the value of the option
 e.g., an option with a vega of 0.30 will gain 0.30% in value for
each percentage point increase in the anticipated volatility of
the underlying asset

 Vega is also called kappa, omega, tau, zeta, and sigma

prime
Sign Relationships

Delta Theta Gamm

a
Long call + - +
Long put - - +
Short call - + -
Short put + + -

The sign of gamma is always opposite to the sign of theta

 Rho
 Rho is the first partial derivative of the with respect to the
riskfree interest rate:

 r (T  t )
 c  X (T  t )e N (d 2 )

 r (T  t )
 p   X (T  t )e N (d 2 )
Thank You