By: Steve Smith
In any endeavor, whether in business, law, medicine, sports, or even parenting, a certain amount of jargon becomes the lingua franca among active participants. It helps people express complex concepts in a concise manner. It also often serves a second purpose of making the “professionals” feel more important and knowledgeable than the layperson.
The options industry is no exception.
One of the mainstays of option language are “the Greeks”, which are used to define how an option’s price will change relative to certain variables. And we’re going to do it in plain English by using the commonly applied applications as opposed to the strict mathematical definitions.
Today let’s focus on Delta:
Delta: This is the expected change in an options’ price for every $1 move in the price of the underlying stock. Delta can range from 0.00 to 1.00, with calls being expressed as a positive number and puts as a negative. The rule of thumb is that an at-the-money option has a delta of 0.50.
It is very important to understand that delta is not fixed. It is a function of the underlying stock price and the time remaining until expiration. As an option moves further into-the-money and time decays, the delta increases at an accelerated rate. Conversely, as an option moves further out-of-the-money and has more time remaining, delta decreases at a slower rate.
For example, if shares of Apple (AAPL) moved from $100 to $105, you could expect the at-the-money $100 call to increase by about $3 a contract, and the at-the-money $100 put to decline by about $2 a contract.
If shares of Apple were to climb to $110, the $100 call, which would be now be $10 ITM, would have increased by around $8, have a delta of around 0.90 while the $100 put, now $10 OTM, would decreased by around $7 have a delta around -0.15
This is a valuable feature of options in that your profits will accelerate as price moves in your direction and losses will decelerate relative to the stock as price moves against you. Conversely it also means that profits pile up quicker as price increases.
The other important reason for understanding delta is that it will help you gear expectations and determine how many contracts might be needed for hedging purposes.