Sunday 9 May 2010

Greeks

It is a little-known fact that the expression "beware of Greeks bearing gifts" is not an oblique reference to the Iliad, but in fact a truism handed down through generations of portfolio managers warning their young kinfolk about the perils of option pricing. The full expression is:
Beware of Greeks bearing gifts, especially vega and leveraged alpha.
Greeks, in financial argot, refer to letters in the Greek Alphabet - alpha, beta, delta, and vega*, and they are approximations representing the market sensitivities of options or other derivatives. Each Greek measures a different aspect of the risk in an option position. Through understanding and managing these Greeks, financial market participants can manage their risks appropriately, whether they deal in OTC or exchange-traded options.
Through mangling them, and particularly by conflating alpha and vega, less talented market participants can make their structured products sound a lot cleverer and more exotic than in truth they really are.

*Classicists may notice that Vega isn't actually a letter in the Greek Alphabet, but a Canadian Singer-Songwriter.

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