Papale on Rho

The Four Greeks

Big sports week.  US Open kicks off – weather permitting, NBA and NHL Finals all underway.  For a sports fan this is a great way to kick off the summer.  Stayed up late with my kids watching the Blackhawks pull one out in triple OT over the Bruins.  All this leading into Father’s Day this weekend.  Good stuff.  Happy Father’s to all the Dads.

The four greeks we and most options traders focus on are delta, gamma, theta and vega.  There is one lesser known greek that gets much less attention is called Rho.  Rho is the sensitivity of an option to changes in interest rates.  Typically, it measures how much the value of an option changes with a 1% change in interest rates.

For example if our rho is 100, than if rates (generally measured by the risk free rate) rise by 1%, our option will increase in value by $100.  Since options are a leveraged instrument, they are affected by the cost of money.  Calls will increase in value generally as rates rise.  This is because calls let us control an underlying for much less out of pocket dollars than buying the underlying directly.  It cost much less money to buy 1 at the money Apple call than to buy 100 shares of Apple stock.  In rising interest rate environments, this lower dollar requirement is attractive so calls get bid up.  Puts tend to act the opposite, dropping as rates rise since theoretically at least, if we short a stock we collect money and could get paid some interest on those dollars.  Buying puts, while giving us a short position in a stock, does not allow us to collect the dollars into our account.  In fact, we have to pay for the put.  So it will become more attractive to sell stock rather than buy puts in times of rising rates.  Rho is not a huge factor but as rates change or if you have a longer dated option, it is something that you might want to keep your eye on.

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