The Option Greeks - Delta

What Is Delta And How Does It Effect Option Prices?

When it comes to options trading terminology, there are a lot of fancy terms out there.

Terms like vega, theta, in-the-money, out-of-the-money, assignment, and more.

No wonder people think options are complicated!

The reality however, is that options are not nearly as complicated as many think.

In fact, when broken down into pieces, the components of options trading can become quite simple for someone new to options trading to understand.

One of the biggest pieces of options trading and one of the most common terms used in options trading is Delta. 

What Is Delta?

Delta simply measures the rate of change of an option's value relative to changes in the underlying asset price.

Delta is one of the commonly used option greeks that traders use to manage an options position.

Another way to think of delta is simply how much the value of a call or put changes based on a one point move in the underlying asset whether it is a stock or a commodity futures contract.

Call options have positive deltas while put options have negative deltas.

For example, suppose shares of XYZ are trading at $20 per share.

A deep in-the-money call option such as a $10 call will have a delta close to 1.00 .

An at-the-money such as the $20 call will have a delta of about .50.

A deep out-of-the-money call such as a $30 call with have almost no delta, perhaps .05.

Using these inputs, for every single point move in the stock the calls would increase in value by 1.00 for the $10 calls, .50 for the $20 calls, and by just .05 for the $30 calls.

Delta therefore, can tell a trader how much they can expect their option to increase in value should the stock or asset move higher.

If the asset or stock moves higher, call deltas will increase while put deltas will decrease.

Although this is not an official definition of delta, one simple way to look at this options Greek is to think of it as the chances of the option going in-the-money.

Using the above example, the $10 call has a very high probability of expiring in-the-money.

The at-the-money $20 call has about a 50/50 chance, and the $30 call option only has a very small chance, hence the low delta of only .05.

One must remember that in - the-money options act and move more like the corresponding asset while out-of-the-money options see much less effect from movements in the underlying.

Therefore, options with higher deltas will have higher premiums while options with lower deltas will have lower to minuscule premiums.

How Is Delta Used?

There are numerous ways to use delta to structure a position in a market that fits an investor's risk parameters.

One very common use of delta calculations is for investors who would like to put on a position in a market that is neutral.

In other words, by using deltas one can potentially profit on a stock or future without having to guess the market direction.

Delta is also what investors use to gauge their market exposure.

By tracking position delta, one is able to see how their position may be effected by different outcomes in the underlying asset.