Gamma, the Change in Delta

It is time again for another lesson on options. Let me first apologize for the lack of updates recently; with final exams and the holidays I have been a bit distracted. However, that is about to change, so let's get started!

What is Gamma?

The Gamma of an option is directly related to the delta of an option. Gamma measures the change in the delta of an option as a stock moves up or down. It may sound confusing, but the basic application is relatively simple. If you have a call option with a delta of .5 and a gamma of .17 and the underlying stock moves up a full point then the delta of the option will move up to .67!

I know what you're thinking. "So, that's cool Spencer; I can figure out the delta of a stock while it's on the move… very useful…" Save the sarcasm. Gamma is much more useful than it first appears.

The Delta Hedge and Gamma

When you are short options you can have a complete hedge by owning the amount of shares equivalent to the delta. Say you are short one call option with a delta of .5. You can be totally hedged by simply owning 50 shares of the underlying stock, but what if the stock moves up or down? This is where the gamma comes in handy. By knowing what the gamma is you know how quickly your position can turn sour.

Delta decays with time, where gamma increases until expiration. Because of this, it is safest to be short options when there is a while until expiration. When expiration you want to be in a position where you maximize gamma, and if the price spikes in your direction you will be in for a good deal of profit!

Stay tuned for more on the Greeks!

Until next time,

Spencer Sundahl

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