The Power of Options Delta
Options Delta of a call can range from 0.00 to 1.00; the delta of a put can range from 0.00 to –1.00. Long calls have positive delta; short calls have negative delta. Long puts have negative delta; short puts have positive delta.
Long stock has positive delta; short stock has negative delta. The closer an option’s delta is to 1.00 or –1.00, the more the price of the option responds like actual long or short stock when the stock price moves.
We sell option premium and pick stock options with the right kind of Delta. Watch the following video about options delta definition
So, if the XYZ Aug 50 call has a value of $2.00 and a delta of +.45 with the price of XYZ at $48, if XYZ rises to $49, the value of the XYZ Aug 50 call will theoretically rise to $2.45. If XYZ falls to $47, the value of the XYZ Aug 50 call will theoretically drop to $1.55.
If the XYZ Aug 50 put has a value of $3.75 and a delta of -.55 with the price of XYZ at $48, if XYZ rises to $49, the value of the XYZ Aug 50 put will drop to $3.20. If XYZ falls to $47, the value of the XYZ Aug 50 put will rise to $4.30.
Now, these numbers assume that nothing else changes, such as a rise or fall in volatility or interest rates, or time passing. Changes in any one of these can change delta, even if the price of the stock doesn’t change.
Below is an interesting video about the four important functions of Options Delta.
1. Option Delta
is the change in the price of an option due to a $1 move in the underlying. The delta of your portfolio is the total directional risk of your positions. Option strikes out of the money moves less than options with strikes in the money. For Puts the option price moves negative direction as the underlying.
2. Share equivalence
When you buy or sell an option Delta will tell you how many shares you are long or short, also called share equivalence. If the delta is 0.82 it means that the option represents 82 shares of that stock.
3. The Hedge Ratio.
Delta will tells us the hedge ratio between the option and the underlying. We can calculate a hedge ratio by dividing the quantity of stock by the option delta: if positive delta is needed: (# of shares/ option delta). It also a good way to learn about the context of size and positioning. It helps you to see how big or how small you are trading.
4. Probability of ITM
So far we’ve given you the textbook definition of options delta. But here’s another useful way to think about delta: the probability an option will wind up at least $.01 in-the-money at expiration.
Technically, this is not a valid definition because the actual math behind delta is not an advanced probability calculation. However, delta is frequently used synonymously with probability in the options world.
In casual conversation, it is customary to drop the decimal point in the delta figure, as in, “My option has a 60 delta.” Or, “There is a 99 delta I am going to have a beer when I finish writing this page.”
Usually, an at-the-money call option will have a delta of about .50, or “50 delta.” That’s because there should be a 50/50 chance the option winds up in- or out-of-the-money at expiration. Now let’s look at how delta begins to change as an option gets further in- or out-of-the-money.
Read more at: http://www.optionsplaybook.com/
Traders use Delta as a powerful tool to determine how much risk they take they sell options in order to receive option premium. When the option price is further out of the money it doesn’t move as much when it is in the money. Options Delta is also used to determine how much risk you take on. It also represents how much shares a position represents. You may use this to hedge your position or portfolio. Another way is to use delta to determine what the probability of an option is to make money.