- Dimensions of risk involved in taking a position in an option (or other derivative). Each risk variable is a result of an imperfect assumption or relationship of the option with another underlying variable. Various sophisticated hedging strategies are used to neutralize or decrease the effects of each variable of risk.
Neutralizing the effect of each variable requires substantial buying and selling and, as a result of such high transactions costs, many traders only make periodic attempts to rebalance their options portfolios.
With the exception of vega (which is not a Greek letter), each measure of risk is represented by a different letter of the Greek alphabet:
Δ(Delta) represents the rate of change between the option's price and the underlying asset's price - in other words, price sensitivity.
Θ(Theta) represents the rate of change between an option portfolio and time, or time sensitivity.
Γ(Gamma) represents the rate of change between an option portfolio's delta and the underlying asset's price - in other words, second-order time price sensitivity.
ϒ(Vega) represents the rate of change between an option portfolio's value and the underlying asset's volatility - in other words, sensitivity to volatility.
ρ (Rho) represents the rate of change between an option portfolio's value and the interest rate, or sensitivity to the interest rate.
Investment dictionary. Academic. 2012.
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