Option Greeks

The speaker covers two of the key option greeks, vega and rho.  Vega represents an options price change in response to changes in volatility while rho represents an options pricing adjustment in response to interest rates. 

Higher vega, or volatility, increases the price of an option.  Option buyers want to get into an option when the volatilty is low. 

Rho is the least used component of option price.  Rising interest rates will increase the value of a call option while decreasing the price of a put option.  Decreasing the interest rates will have the opposite effect.

The speaker discusses the time value of options, or theta.  Theta is the value associated to the time component in an option.  An option with a greater term to expiration will have theta representing a higher percentage of the option value.  He walks through an example of a trader which purchased deep out of the money calls to take advantage of higher prices in months to come.  The problem with this strategy is that the majority of the option premium is theta, or time.  As time starts to pass, theta will decay and therefore so will the price of the option.  A dramatic move will need to happen to even break even in this type of situation. 

The speaker provides reasoning to why a delta-neutral hedge is not sufficient in mitigating risk.  A delta neutral portfolio is only delta neutral for a point in time.  The speaker provides a real trading example with the dollar/euro forex pair.  To create a delta neutral hedge, he shorts the Euro.  However, once the currencies start moving significantly in either direction, the hedge is insufficient.  In this case, delta will change and the hedge will not be delta neutral any longer; hence, requiring the porfolio to be rebalanced.  This is called dynamic delta hedging.