What Is Color?

Color is an option's "greek" that measures the rate at which gamma will change over time. Color is also known as gamma decay or the derivative o𒁏f gamma wi🌼th respect to time.

Understanding Color

More specifically, color is the third-order derivative of an option's value, once to time and twice to the option's price. Gamma measures the change in delta in response to a one-unit price move in the 澳洲幸运5官方开奖结果体彩网:underlying asset, and delta measures ⛦how a derivative moves in response to a p💜rice change in the underlying.

Options greeks measure many characteristics of options pricing, from how fast the options price changes with respect to the price changes in the underlying asset, called delta, to the rate of decay of the option's time value, called theta.

To understand color, it is important to first understand gamma, since color i🥀s measuring how gamma will change over time.

Gamma measures the rate of change in an option's delta per one-point move in the underlying asset's price. Delta is a first derivative, gamma a second, and color a third. Color is an important trait to monitor when maintaining a 澳洲幸运5官方开奖结果体彩网:gamma-hedged portfolio because it helps the trader ga🌞uge the effectiveness of💜 the hedge over the passage of time.

Gamma is also used when trying to gauge the price movement of an option, relative to the amount it is in or out of the money. When the option being measured is deep in or 澳洲幸运5官方开奖结果体彩网:out of the money, gamma is small. When the o🔯ption is near or at the money, gamma is at its largest. Gamma is also larger closer to expiration, and smaller the 🅰further away it is from expiration.

All options that are a 澳洲幸运5官方开奖结果体彩网:long position have positive gamma, while all 澳洲幸运5官方开奖结果体彩网:short options have negative gamma.

Traders who use a gamma-hedging options trad♛ing strategy use color to capture information on the gamma of an option per year. The daily figure can be found by dividing the result by the ♔number of days in the year.

Color provides a more reli✅able figure when the option is far from expiration. However, as expiration draws near, color becomes more volatile, can change i🏅ntraday, and is less reliable.

Other third order greeks include speed which is the rate of change of gamma in regards to the underlying price, ultima, and zomma.

Borrowing from physics, if delta is the velocity of options price movement with respect to the underlying, then gamma is the acceleration. Since th🔯e third derivative is a bit hard for non-scientists to grasp, we can move these greeks down on♓e level. Now consider gamma to be the velocity of delta and therefore color is the acceleration of gamma.

Gamma expands as expiration draws near and color measures it. Gamma also expands as the option moves closer to 澳洲幸运5官方开奖结果体彩网:at-the-money, and color also measures this. If gamma is small because the option is far from expiration, or because the underlying asset is far 🍃from the strike price, then color will reflect this.

Example of Color in Option Trading

Assume that an option has a delta of 0.65. That means that for each $1 move in the stock price, the option's price is expected to move $0.65, all else remaining equal.

Now assume that this option has a $10 strike price and the underlying is currently🔥 trading at $11. The stock price is going up and soon reaches $12, putting the stock even more in the money. The delta of the stock is now 0.90.

An in-the-money option will also see its delta increase as the time to expiration draws nearer. In any case, for each dollar move in the stock, the option is now moving $0.90. The difference between the old delta an🌜d the new is what gamma is measuring. Gamma increased by 0.25 [$0.90 - $0.65]. Note though, gamma will start to decrease the closer delta gets to one because once delta is at 0.90 it can only increase by 0.10, which is less than what it was increasing before.

Color is an extension of gamma, measuring how much it moves over time. Color shows how much gamma is expected to change. The daily amount shows how much the gamma is expected to change each day. A color of 0.03 means gamma will fluctuate approximate🌃ly 0.03 per day. A reading of 0.1 means gamma will fluctuate 0.1 per day.

As⛄ the price approaches expiration, color is more prone to rapid change and is therefore not as reliable.