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1 July 1994 Financial Analysts Journal Volume 50, Issue 4

Translating the Greek: The Real Meaning of Call Option Derivatives

  1. Don M. Chance
The derivatives of a call option's price with respect to the stock price, volatility, risk-free rate, exercise price and time to expiration indicate how the option price will change as the underlying inputs change. Option users must understand the significance of these derivatives. Some of the traditional interpretations of these concepts are misleading. At best, they provide only partial explanations for what is really happening. Decomposing a call into a margin transaction and an insurance policy provides clearer interpretations. For example, increased volatility has no impact on the value of the margin-position component of the call. It does, however, increase the insurance value of the option. A longer time to expiration (traditionally viewed as beneficial, giving the asset more time to appreciate) in fact increases the value of the margin position but can increase or decrease the insurance value.
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