Understanding Delta

It’s time to start talking about the Greeks. The Greeks are a set of analytical tools to help you build and maintain your options positions. You can find the various ‘greek’ values for an option online at your broker’s website, or at ivolatility.com. The first one we are going to talk about is Delta. So what is delta, and what purpose does it serve?

The Delta

Conceptually, delta is very simple to understand. For a call it is the percentage an option will increased based on an increase in the underlying security. And for a put it is the percentage (as a negative) based on a decrease in the underlying security.

For example:

You have a call option with a delta of 25%. The underlying stock increases in value by $1.00. $1.00 x 25% = $0.25. Thus, your option increases in value by $0.25! If the stock fell by a dollar instead of gaining, you would lose $0.25.

You have a put option with a delta of -25%. The underlying stock falls in value by $1.00. -$1.00 x -25% = $0.25. (Notice the negatives cancel each other out, thus making a positive gain for your option.) and so your put increases in value by $0.25! If the stock increased in value by a dollar, you would lose $0.25.

Practical Use of Delta

So aside from number crunching how much you might make in a day with your options why is delta so useful? Delta is a great tool because it allows you to create positions that are delta neutral. This means the delta of your position is 0. Delta neutrality is a strategy generally used when talking about straddle and strangles, which use a mix of calls and puts. Both of which are volatility trading strategies that we will cover in the very near future. When a position is ‘delta neutral,’ it will gain as much to the upside as it will to the downside. An important factor when creating a complex options position. Aside from this, delta is a great analytical tool to use to create a partial hedge. It is also very useful if you are trading the futures market.

Delta is a great asset to any options trader. Especially, one who is managing more complex positions than a long call or put. Despite Delta’s greater use for more complex positions, it is still quite useful for basic analysis as well. Next, we are going to talk about another of the ‘Greeks,’ the Gamma of an option.

Until next time,

Spencer Sundahl