Lambda

What is Lambda?

In Options Trading, Lambda is referred to a Greek letter that is assigned to a variable which signifies the ratio of how much an option is Offering the leverage as the price of that specific option fluctuates.

This measure is also known as the leverage Factor. And, in certain countries, it is known as effective Gearing. In simple words, Lambda demonstrates the leverage ratio that an option will offer as the Underlying asset’s price changes by 1%.

Explaining Lambda

Lambda is one evaluating factor that is regarded as one of the minor Greeks. It is not extensively used as the majority of its identifications can easily be found out with a combination of other option Greeks.

But the information that Lambda offers is essential for comprehending the amount of leverage a trader is employing into a certain option trade. While leverage is an important factor for a trade, Lambda turns an effective measure.

A straightforward lambda calculation decreases to the Delta value multiplied by the stock price ratio and divided by the option price. Basically, Delta is one standard Greek that represents the amount an option price is anticipated to change in case the Underlying Asset changes its price.

Lambda Example

Let’s take a lambda example here. Suppose a stock share is trading at Rs. 100 and the at-the-money Call Option for Rs. 2.10 with a strike price of Rs. 100. Now, assume that the delta score is .58. now, the lambda value can be calculated as:

.58 x (100/2.10) = 27.61

This value will be equal to the Lambda of the equation, which is 27.61, in this case. This value of Lambda signifies the comparable leverage in the option is compared to the stock. Thus, a 1% increase in the stock holding’s value will result in the 27% increase in the same value held in the option.

Now, consider what is going to happen to an Rs. 1000 stake in this Rs. 100 stock. The investor holds 10 shares and in case the stock, in this example, has increased by 1% (from Rs. 100 to Rs. 101 per share), the investor’s stake will increase in value by Rs. 10 to Rs. 1010.

However, in case the investor held the same Rs. 1050 stake in the option, the resulted upsurge in the value of the stake will be extremely different.