When you are learning something new it can seem as though people are speaking another language. In the case of futures option trading, this is not just an illusion. Many of the terms applied to options will be new but some of the most common are actually referred to as: Delta, Theta, Gamma and, although it is not a Greek letter, Vega are their names and once you learn option trading these terms will become quite familiar to you.
You may feel like it is confusing but don’t let the names overwhelm you. Each of the terms has a specific definition when referring to options on futures contracts and each one is important. Even if you learn them and never think of the terms again, they are an ever-present feature of options trading strategies and can definitely be of great educational value to any option trader.
Alone or as part of an option pricing model, the terms can give you important signals and clues about option pricing and the behavior of option price relative to the futures market that the option is derived from. The terms can be as important to options as government reports and statistics are to a futures market and you will want to learn more about the terms to help enhance your options trading strategies.
Delta is a measure of the rate of change in option premium compared to the rate of change on a futures contract. Many options trading strategies will use delta to establish specific trading goals. You may have heard the term “delta neutral trading” and as you learn option trading you will have a better understanding of this and other options trading strategies.
The rate of change in delta is known as gamma. Theta measures the rate of premium decay over time, getting faster as the option nears expiration and vega assesses the sensitivity of option premium to the underlying market’s volatility. All of the option terms will affect your options trading strategies to one degree or another and when you learn option trading they will also help highlight areas of options pricing that you may never have considered. Being aware of how options are priced and the theories behind the terms are integral parts of planning options trading strategies.
As a whole group, the terms work together with the Black-Scholes option pricing model to help you to better understand options and help you add knowledge to option trading.
Trading in futures and options involves a substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results.
