Options traders have a number of resources at their disposal. Greeks, for example, can help analyze the effects of a number of factors on an option. The most widely used greek, which is delta, is one such potentially powerful tool. If you trade options, incorporating delta into your analysis can be a critical component of success.
What is delta?
Essentially, delta is a measurement of an option's price sensitivity to a given change in the price of an underlying asset. As a result of each $1 move for a stock, option prices tend to adjust by the amount of the delta. So, if the delta is .30 for a specific option contract, for each $1 move the option price may move by $0.30.
However, an option price will not always move exactly by the amount of the delta. Delta is a dynamic greek that is constantly changing because it is impacted by other factors. For instance, another greek, called gamma—which is the rate of change of delta when the underlying security moves—impacts the delta of an option.
Here are a few other helpful principles about delta that are worth considering:
- All else being equal, an in-the-money call option's delta will move toward 1 at expiration, and an in-the-money put option delta will move toward –1 at expiration.
- Delta may be more sensitive to time until expiration and volatility the further in the money or out of the money the option is.
Uses of delta
Another way that traders use delta is to measure their exposure to the underlying stock. For example, if a long call is showing a delta of .30, the trader might think of the position as if he were long 30 shares. This may simplify the analysis.
Yet another application of delta is that it can provide a probability estimate of the likelihood that the option will be in the money by expiration. If your long call is showing a delta of .30, some traders may think of this as having approximately a 30% probability of being in the money. This can be used as a risk management tool.
Probability will be a moving target as well, because time and movement of the underlying security will adjust the percentages as you go. Nevertheless, the power of delta can be used in several ways to design your options strategies. Of course, delta is just one piece of the puzzle when looking at trading options. For the experienced options trader, accessing an approximation of the probability of profit can be a powerful tool.