This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Ways to Think About Delta

TheStreet Premium Services

A complimentary preview
of Options-Profits Previews

Standard accounts of the option Greeks will explain that delta measures the rate of change in the price of an option per unit change in the underlying asset. The text I use with clients provides some additional helpful ways of thinking about delta:

- as a ratio of underlying contracts to options required to establish a neutral position, e.g. for every five 40-delta calls purchased, two underlying contracts (or 200 shares of stock) should be sold short;

- as an equivalent to the underlying, e.g. a 40-delta call is equivalent to owning 40 shares of stock;

- as the probability that an option will expire in-the-money.

But even books devoted to options don't often discuss the difference between the deltas of options with identical strike prices but different expirations. As expiration approaches, the delta of in-the-money options approaches one, while the delta of out-of-the-money options approaches zero. Known also as "charm," delta decay is a second-order Greek that measures the rate of change of delta per day.

The chart below illustrates the phenomenon of delta decay nicely. In this example, with SPDR Dow Jones Industrial Average (DIA) near $108, the 114 call options expiring in October have hardly any delta at all, while the 114 calls expiring in June have a delta above 30. The converse is true for ITM options: October DIA 100 calls have a delta above 90, but that number drops to just above 60 for the 100 calls expiring in June. Delta decay is of particular interest to traders holding ATM or OTM options near expiration, especially when those options are serving as portfolio hedges.

Delta Decay
Source: Condor Options

OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits

Jared can be followed on Twitter at twitter.com/CondorOptions

 

EXCLUSIVE OFFER: Jim Cramer's Protégé, Dave Peltier, only buys Stocks Under $10 that he thinks could potentially double. See what he's trading today with a 14-day FREE pass.



Brokerage Partners

Top Rated Stocks Top Rated Funds Top Rated ETFs