Option Delta: How Options Move

 

 

 

 

 

Option delta is represented as the velocity of a price change in an option, given a 1 point move in the underlying asset and is usually displayed as a decimal value. Delta values range between 0 and 1 for call options and -1 to 0 for put options.

The delta of an option is the sensitivity of an option price to movement in relation to changes in the price of the underlying asset. It tells option traders how fast the price of the option will change as the underlying stock moves. A deep in the money option that is close to expiration will move 100% in step with its underlying stock with a 1.00 delta. While a near term at the money option will have a delta of .50, it will move 50% in step with its underlying stock. If your stock is at $100 and you have a $100 strike call option and the stock goes up $2.00 your option with a .50 delta will only go up $1.00. As an option gets deeper in the money and the odds of it retaining its intrinsic value increases and the delta grows in relation to the odds of it keeping its intrinsic value. At the money the odds are 50/50 as to its movement. As it gets deeper in the money the odds grow to 60%, 70%, or 80% of it staying in the money.

Note that calls and puts have opposite deltas – call options are positive and put options are negative. A put option moves inversely to a call option.

Whenever you are long a call option, your delta will always be a positive number between 0 and 1. When the underlying stock or futures contract increases in price, the value of your call option will also increase by the call options delta value. Conversely, when the underlying market price decreases the value of your call option will also decrease by the amount of the delta.

Put options have negative deltas, which will range between -1 and 0. When the underlying market price increases the value of your put option will decreases by the amount of the delta value. Conversely, when the price of the underlying asset decreases, the value of the put option will increase by the amount of the delta value.

What many do not understand is that delta is a good measure of odds. An at the money option has 50/50 odds of it going either way and that is reflected in the delta of .50. However if you are buying a far out of the money option with a delta of .10 that moves only one tenth in step with the underlying asset the odds are about 90% that your option will expire worthless. Yes, 1 in 10, those are terrible odds and if your 9 losses all come in a row as the first nine you will blow up your account if you are betting to big. My advice? You sell .10 delta options not buy them (always have a hedge in place, though). These are lottery tickets and we all know that the state always makes money on lottery tickets but only one in a million wins the jack pot. If you want to use options to trade stocks use the ones that are in the money so you only have to be right in the direction of the trade and not the direction, and the time period and the strike price like you have to be right about with out of the money options. No matter how you use options always put the odds in your favor.