Using the Greek 'Delta' in Option Trading
Maximize Your Options Trading Profits by Understanding Delta
Dec 14, 2008
Just how much traction does a trader get with a particular option? That depends on delta, which measures how much an option changes in price compared to how much the underlying stock - or index - changes in price. Every option has a different delta though, meaning one option may provide a trader with more bang for his or her buck than another option would.
In general, most traders tend to underestimate how much an option - whether it be a call or a put - is apt to change relative to the underlying stock's change. This can present a bit of a problem. If a stock's likely or anticipated move is fully completed, but the owner of a call or put on that stock is still (or was) looking for a little more of a gain, then the owner of that option is taking on risk even though there may be no potential of more reward. Indeed, the risk is even greater considering the stock could possibly start to move in the opposite direction once a projected move is complete.
Example
Deltas are typically measured on a per-share basis. For instance, a delta of 0.60 means that for every $1.00 a stock rises, a call option would increase in value by 60 cents per share.
But remember, an option contract represents 100 shares of a stock. So, if the delta is 0.60 and the stock rises by $1.00, that option contract improves in value by $60.
Sometimes an option’s delta is not listed as a decimal, but as a whole number - perhaps '60' in the previous case. However, a delta can never be greater than 1.00, or 100% ... that's just an alternative way of describing how responsive an option is to change in the underlying stock. The more conventional representation is in decimal form.
For put options, since they increase in value as the underlying stock or index moves lower, their delta is given as a negative number. Had a put been considered instead of a call in the above example, and the responsiveness was still 0.60 worth of change for every $1.00 in the underlying, that put would have been given a delta value of -0.60.
Putting the Concept Into Practice
For an option owner, the higher the delta, the better the likely dollar movement from the option as the underlying stock or index moves lower. However, high-delta options usually cost more (and are usually deeper in the money), which can offset the benefit of a strong delta.
There is no particular argument for or against high-delta options. The lesson to be learned is simply that not all options are the same. An individual trader must weigh the upside and the downside of a variety of option trading scenarios to determine which delta makes the most sense with respect to risk and reward.
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