Delta is the Probability an Option makes Money

Delta is a measure that can be used in evaluating buying and selling opportunities. It tells the trader how likely it is that the option is going to be in the money.

Delta is the option’s sensitivity to changes in the underlying stock price. It measures the expected price change of the option given a $1 change in the underlying.

Imagine a stock is at $40 and we’re looking at the two-month, at-the-money (ATM) call with a strike price of 40 and a current price of $3. If the stock goes from $40 to $41 right now, so the only thing that changes is the stock’s price, how much would you expect the call option’s price to move?

The call price should increase by about 50 cents, to $3.50. How do you know? One way would be to look up the option’s delta, +0.50, which you can find in the Options Chains under the Quotes + Research tab.

Using the definition above, if the stock goes up $1, the call price should go up roughly by the amount of delta. Hence, it should go from $3.00 to about $3.50. This also works in reverse. If the stock went down by $1 instead, the call option should go down approximately by the amount of the delta, 0.50 or 50 cents, to a price of $2.50.

 

Probability that the Option is In The Money

Think about Delta as your in-the-money probability There’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.

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