Options Delta

Characteristics of Delta

The delta value of an option is usually expressed as a number between -1 and 1, although it can also be between -100 and 100. This number basically tells how much the price of the option will move for every $1 the price of the underlying asset moves by.

For example, a delta value of .50 (or 50 if the -100 to 100 scale was being used) would mean that the price would theoretically increase $.50 for every $1 the price of the underlying security increases by, and fall $.50 for every $1 the price of the underlying security falls by.

A negative delta value,such as -.50, would mean that the price option would move in the opposite direction to the price of the underlying security. So a delta value of -.50 would mean that the price would theoretically fall $.50 for every $1 the price of the underlying security increases by, and increase $.50 for every $1 the price of the underlying security falls by.

Calls have positive delta values, between 0 and 1, because their value increases when the price of the underlying security goes up and falls in value when the price of the underlying security goes down. Puts have negative delta value, between 0 and -1, because their value falls when the price of the underlying security goes up and increases when the price of the underlying security goes down. The actual delta value of an option will largely depend on two factors: the moneyness and the time left until expiration.

Delta value isn't fixed, and it changes based on market conditions. It will increase as an option gets deeper into the money and decrease as it gets further out of the money. Therefore the delta value of a call will move nearer towards 1 when stock is rising, and nearer towards 0 when stock is falling. On a put it will move towards -1 when the stock is falling, and towards 0 when the stock is rising.

Options that are exactly at the money will usually have a value that is very close to .50. The rate at which the value will change in relation to how the price of the underlying security is moving is measured by another of the options Greeks: Gamma.

The other main factor that affects the delta value is the time left until expiration, because the less time there is until the expiration date, the less time there is for the price of the underlying security to change. Therefore, an option is more likely to stay in its current state of moneyness the closer the expiration date is.

This means that the delta value of in the money calls tends to move towards 1 as expiration approaches (or -1 for put options) while the on out of the money options will usually move towards 0.

Putting Options Delta to Use

There are essentially two main ways that an options trader can use delta. It's important to remember, though, that this value is only an indication of how the price of an option is likely to change and not a guarantee of how it will change.

The primary use of delta is to give you an idea of how much money you will make if the underlying stock moves as you expect it to (or how much you will lose if the underlying stock moves in the opposite direction). This can then help you determine which options give you the best value for money in terms of taking advantage of what you expect to happen.

For example, you might believe that stock in Company X is going to increase in price by a certain amount over a specific period of time. By studying the delta values of the relevant calls with different strike prices you can then try to work out how to maximize your potential returns, or minimize your potential losses.

At the money contracts will be cheaper than in the money contracts, and out of the money contracts will be cheaper still. By comparing the price of those contracts with their delta values, you can work out how much you would expect to make if Company X does move as you expect it to. It may be that you stand to make a better return on your investment with the cheaper out of the money contracts, or it may be that the in the money contracts will work out better for you.

The second main use is based on probability. The delta value of an option can be used to determine the approximate probability of it expiring in the money. The closer the delta value is to 0, the less chance it has of finishing in the money. Conversely, calls options with a delta value close to 1 and puts options with a value close to -1 have a very high chance of finishing in the money.

Although the calculations behind delta aren't specifically related to probability in this sense, it's still a reasonable way to gauge the rough likelihood of an option expiring in the money. In turn, this can help you know which trades to make as you can weigh up the risks involved in a trade against the strength of your expectation for what will happen to the relevant underlying stock.

When creating spreads, it can be a good idea to calculate the total delta value of the spread. This is a simple calculation where you just add up the value of all your positions. For example, if you owned two calls that had a value of .60 and one put with a value of -.40, then your position has a total delta value of .80 (2 x .60 = 1.2, plus -.40 - .80).

Delta values can also be used to set targets for your trades, and to decide at what point you should close a trade and take your profits or cut your losses.