Understanding Options Delta
Understanding Option “greeks” like Delta is an important fundamental to understanding why an options moves the way it does and helps in determing how to manage your option trades.
Below is a summary of understanding Delta for options:
Delta represents options price move in relation to a $1 change in underlying price so a call option with .50 delta means it moves $0.50 for every $1 move in the underlying stock so the higher the delta number the higher the relative move of the option
Calls with +1.0 Puts with -1.0 delta means they move dollar for dollar with the underlying stock price. The farther in the money an option is, the higher the delta
As delta increases and option becomes more in the money, then time value will convert into intrinsic value because there is a higher likelihood of the in the money options expiring in the money.
For monthly options people like to use delta to measure probability of expiring in/out of the money……..so if you sold a call with .15 delta then that means the market is pricing in a 15% chance of that call expiring in the money.
An important point to understand is that delta can move quickly as you go into final month of expiration depending on if options in/out money because delta is measuring likelihood of expiring in/out the money
Essentially if you are short an option for an income trade where you don’t own or want the underlying stock then many times you want low delta so that it doesn’t move on you with the move in the underlying
For income traders people like to manage their portfolio with neutral delta so that you can gain income from theta(time decay) without being exposed as much
Pay attention to implied volatility because it can affect delta…higher IV adds time value and lower IV takes takes it away.
An increase in IV will increase the deltas of OTM(out of money) option and decrease delta of ITM(in the money) options…..actual volatility has similar affect…..this affect of volatility on delta is because it means OTM call have a greater chance of winning and the ITM call a greater change of losing on volatility stocks
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