BASICS OF OPTION GREEK

A bull call spread, or bull call vertical spread, is created by buying a call and
simultaneously selling another call with a higher strike price and the same
expiration. The spread is profitable if the underlying asset increases in price, but
the upside is limited due to the short call strike. The benefit, however, is that
selling the higher strike call reduces the cost of buying the lower one. 
A  bear put spread, or bear put vertical spread, involves buying a put and selling
a second put with a lower strike and the same expiration.
If you buy and sell options with different expirations, it is known as a calendar
spread, or time spread.
A butterfly consists of options at three strikes, equally spaced apart, where all
options are of the same type (either all calls or all puts) and have the same
expiration. In a long butterfly, the middle strike option is sold and the outside
strikes are bought in a ratio of 1:2:1 (buy one, sell two, buy one).
The value of a butterfly can never fall below zero.  Being long a butterfly profits
from a quiet market.

PUT-CALL PARITY 
We addressed briefly how a synthetic position in the underlying can be created
from options. Combining options positions with the underlying can also produce
synthetic options. This has to do with what is known as put-call parity, where:
Call Price – Put Price = Underlying Price – Strike Price.
Rearranging this equation, we can create a synthetic long call for a given strike
price by buying a put and also buying the underlying. Similarly, a synthetic put is
a long call combined with going short the underlying. You can also create other
combination strategies that include a trade in the underlying, such as a collar or
risk reversal.
 
A collar option strategy is an option strategy that limits both gains and losses. A
collar position is created by holding an underlying stock, buying an out of the money
put option, and selling an out of the money call option.
Options prices can be modeled mathematically with a model such as Black-
Scholes. This particular feature of options actually makes them
arguably less risky than other asset classes, or at least allows the risks
associated with options to be understood and evaluated.
 Individual risks have been assigned Greek letter names, and are sometimes
referred to simply as the Greeks.
Delta is the change in option price per unit (point) change in the underlying price,
and thus represents the directional risk. Delta is interpreted as the hedge ratio, or
alternatively, the equivalent position in the underlying security: a 100-delta
position is equivalent to being long 100 shares.
An easy way to think about delta is that it can represent the probability that an
option has of finishing in the money (a 40-delta option has a 40% chance of
finishing in the money). At-the-money options tend to have a delta near 50. Think
about it this way, if you buy a stock today, it has a 50% chance of going up and
50% chance of going down. In-the-money options typically have a delta greater
than 50, and out-of-the-money options are typically less than 50. Increasing
volatility or time to expiration, in general, causes deltas to increase.
 
Gamma measures the change in delta per unit (point) change in the underlying
security. The gamma shows how fast the delta will move if the underlying
security moves a point. This is an important value to watch, since it tells you how
much more your directional risk increases as the underlying moves. At-the-
money options and those close to expiration have the largest gammas. Volatility
has an inverse relationship with gamma, so as volatility increases the gamma of
the option decreases.
Theta measures the change in option price per unit (day) change in time. Also
known as time decay risk, it represents how much value an option loses as time
passes. Long-term options decay at a slower rate than near-term options.
Options near expiration and at-the-money have the highest theta. Additionally,
theta has a positive relationship with volatility, so as implied volatility increases,
theta also generally increases.
Vega measures the sensitivity of an option to volatility, represented as the
change in option price per unit (percent) change in volatility. If an option has a
vega of .2 and the implied volatility increases by 1%, the option value should
increase by $.20. Options with more time till expiration will have a higher vega
value compared to those nearer to expiration. At-the-money options are most
sensitive to changes in vega.

 The premium of an option increases as the chances of the option finishing

in-the-money increases.
 In the money, at the money and out of the money refer to moneyness, an
aspect of options trading that has important implications.

 
deep-in-the-money options present profitable opportunities for traders. For
example, buying a deep-in-the-money call option can present the same profit
opportunity in terms of dollars as purchasing the actual stock but with less capital
investment. This translates into a much higher return. Selling deep-in-the-money
covered calls presents a trader with the opportunity to take some profit
immediately, as opposed to waiting until the underlying stock is sold. It also can
be profitable when a long stock appears to be overbought, as this would increase
the intrinsic value and often the time value, due to the increase in volatility.
Call Option Intrinsic Value=Underlying Stock′s Current Price−Call Strike Price
Put Option Intrinsic Value=Put Strike Price−Underlying Stock′s Current Price
For example, let's say General Electric (GE) stock is selling at $34.80. The GE
30 call option would have an intrinsic value of $4.80 ($34.80 – $30 = $4.80)
because the option holder can exercise his option to buy GE shares at $30,
then turn around and automatically sell them in the market for $34.80—a profit of
$4.80.
Options trading at the money or out of the money, have no intrinsic value.

Time Value
 
The time value of options is the amount by which the price of an option exceeds
the intrinsic value. It is directly related to how much time an option has until it
expires, as well as the volatility of the stock. The formula for calculating the time
value of an option is:
Time Value = Option Price-Intrinsic Value 
 The time component of an option decays exponentially. As a general rule, an
option will lose one-third of its value during the first half of its life and two-thirds
during the second half of its life. Time value is often referred to as extrinsic value.
 
 Historical volatility looks back in time to show how volatile the market has been.
This helps options investors to determine which exercise price is most
appropriate to choose for a particular strategy.
Implied volatility measures what options traders expect future volatility will be. As
such, implied volatility is an indicator of the current sentiment of the market.
The Directional Covered Call Without The Stock

In this iteration of the covered call strategy, instead of buying 100 shares of stock
and then selling a call option, the trader simply purchases a longer dated (and
typically lower strike price) call option in place of the stock position and buys
more options than he sells. The net result is essentially a position also referred to
as a calendar spread. If done properly, the potential advantages of this position
relative to a typical covered call position are:

 Greatly reduced cost to enter trade

 Potentially higher percentage rate of return
 Limited risk with the potential for profit.

 
An Example

To better illustrate these potential benefits, let's consider one example. The stock
displayed in the left hand pane of Figure 1 is trading at $46.56 and the December
45 call option is trading at $5.90. The typical buy/write play is built as follows:

 -Buy 100 shares of stock at $46.56

-Sell one December 45 call at $5.90.

Now let's consider an alternative to this trade, using just options to craft a
position with a lower cost, a lower risk and greater upside potential.

 For this example we will:

 -Buy three January 40 calls @ $10.80
 -Sell two December 45 calls @ $5.90

There is another version of the covered-call write that you may not know about. It
involves writing (selling) in-the-money covered calls, and it offers traders two
major advantages: much greater downside protection and a much larger
potential profit range.