Rho is an important measure among the Option Greeks. Whereas, the Options Greeks refer to different dimensions of risk associated with options trading. Delta, Gamma, Theta, Vega, and Rho are among the major Greeks. There are some minor Greeks as well but they aren’t used as often as major Greeks are used.
Rho gauges the sensitivity of the price of an option to interest rates. Although the interest rate doesn’t affect the value of an option, it is still an important measure. If you want to learn all about this Greek value, then you are on the right platform. In this article, we are going to explain Rho in detail. Let’s dive deep to learn.
Rho is an Option Greeks value that measures the rate of change in the value of an options contract with a 1% change in the interest rate. In other words, it enables you to gauge the sensitivity of option contracts to interest rates.
In the simplest terms, Rho value indicates how the value of an options contract changes with a 1% change in interest rates. The interest rate here is the risk-free interest rate and 3-month treasury bills are typically used for it. Let’s suppose that the Rho value of an option is 1, then every 1% change in risk-free interest rate will increase the option’s value by $1. For instance, if the price of the underlying security is $9 and the interest rate increases by 1%, the value of the option moves to $10.
Furthermore, it is also important to note that changes in interest rates affect different types of options in different ways. Put options’ value decreases with an increase in interest rates. Conversely, call options’ value increases with increased interest rates. That also means that the Rho value can be both positive and negative. Put options have a negative Rho value whereas call options have a positive value.
Again, let’s take an example to understand this. Say that a put option has a price of $9 and the Rho value associated with it is -0.25. Now, if the interest rate increases by 1%, the price of the put option decreases by $0.25. Contrarily, if the interest rate decreases by 1%, the value of the put option increases by $0.25. Similarly, if we take the call option and suppose that a call option has a price of $9 and the Rho value associated with it is 0.25. Now, if the interest rate increases by 1%, the price of the put option also increases by $0.25. Similarly, if the interest rate decreases by 1%, the value of the put option decreases by $0.25.
Rho and other key aspects
As you know, changes in interest rates affect different options contracts in different ways. There are some other important aspects you need to understand. For instance, in-the-money options have larger Rho that steadily decreases as the options move to out-of-the-money. Contrarily, out-of-the-money options have low value whereas the value tends to rise in the case of at-the-money options. However, the most important aspect here is the expiration.
Changes in interest rates greatly affect option contracts with longer expiration periods. So, they have a higher Rho value. As a simple rule, the value increases as the expiration period increases. That’s why Long-term Equity Anticipation Options (LEAPs) have larger Rho values because they have an expiration period of up to 1 year or even more than 1 year.
Rho is an Option Greeks value that measures the sensitivity of option contracts to changes in interest rates. It is among the least used Options Greeks and traders consider it a complicated measure. However, you can use it to clear your doubts when it comes to using options with long expiration periods. It is almost irrelevant for options with a short expiration date as the interest rate has minimal impact in this case. Moreover, it is also important to keep in mind that different types of options contracts have different Rho values. Simply put, it is entirely up to you whether you want to use Rho or not but it is important to understand what it means and how it works.