D is for Delta

While most private investors or home traders don't need the metrics of risk calculation popularly known as "the Greeks" the most basic one, Delta, can be helpful.

Every option has a Delta and this measures 
the rate of change of the price of the option with respect to the price of the underlying value. The Delta of an option ranges in value from 0 to 100 for long calls and short puts and 0 to -100 for long puts and short calls. Delta  reflects the increase or decrease in the price of the option in response to a 1 point movement of the underlying asset price.So if XYZ moves up one dollar, an at the money (ATM) call should rise by .50 and an ATM put should fall by .50.

Far out of the money (OTM) options have deltas near zero and deep in the money (ITM) options have a Delta approaching 100. For this reason, the Delta of an option can also be seen as a percentage of the chance an option has of expiring in the money. With XYZ at 100 both the 100 call and put have an equal chance of expiring ITM so both have a Delta of 50.

As the time remaining to expiration grows shorter, the time valuef the option evaporates and correspondingly, the Delta of ITM options increases while the delta of OTM options decreases. For this reason, today's Delta is not tomorrow's Delta.

Time to Expiration and its Effects on Option Delta

As volatility rises OTM Deltas tend to rise and ITM Deltas tend to fall. This is because in a volatile stock what was ITM today has a greater chance of being OTM later and vice versa. As volatility decreases OTM options tend to lose Delta as their chance of expiring in the money decreases.


Delta is also useful as a hedge ratio. In other words, how much of the underlying value do you need to trade in order to be Delta, ie directional, neutral. So, if I sell 10 ATM calls with a Delta of 50 I need to buy 500 shares to stay neutral.

When running a large option position across many series and months it is useful to know the Delta of the entire position as it provides a measurement of directional exposure.

Delta does not measure time decay exposure (that is called Theta) or volatility exposure (known as Vega). As I say, these measurements are not necessarily needed by the average home trader but are very
Market News and Data brought to you by Benzinga APIs
Comments
Loading...
Benzinga simplifies the market for smarter investing

Trade confidently with insights and alerts from analyst ratings, free reports and breaking news that affects the stocks you care about.

Join Now: Free!