Delta is one of the Greeks that options traders sometimes use to better understand and analyze options positions. It measures the amount that a value that a put or call option contract is expected to change for every one point move in the underlying asset. Delta can also be used to determine the probably that a contract will expire worthless. It's arguably the most useful and widely-used of the Greeks.
If you want to know how much a call will increase in value if the stock moves higher, you can get a general idea by looking at the option's delta. If, for example, the contract has a delta of .20, the contract will increase in value by $0.20 for every $1 increase in the underlying stock. It will lose 20 cents if shares drop a $1. Put options have negative deltas because they lose value as the stock rises and increase in value as shares fall. A call option has a delta ranging between 0 and 1 and puts have deltas between -1 and 0.
While delta and other Greeks are computed using options-pricing models, many options-related web sites and online brokers offer options chains that include the numbers. The one for BofA (BAC) - Get Bank of America Corp Report options below is from optionsXpress. An April 14 call option currently has a delta of .31 and if BAC sees a sudden $1 spike, the call can be expected to increase in value from $0.15 to about $0.46. Importantly, however, deltas are always changing with the price of the underlying asset. (The amount of change in delta for every point change in the stock is measured by another Greek - gamma.)
Moneyness is important when looking at delta. A call option is in-the-money
ITM when the stock price is trading above the strike price of the options contract and is out-of-the-money
OTM when the stock price is below the strike price. The opposite is true for puts. As a general rule, ITM options are more responsive to changes in the underlying stock and have higher deltas than OTM options. At-the-money
ATM call options, where the strike price equals the stock prices, have deltas near .50.
The time left until expiration is also an important determinant of delta. As expiration approaches, the delta of an ITM option will approach 1. There is very little time value remaining in the options contract and it will be very sensitive to changes in price of the underlying stock. This also means that you get a lot of bang for your buck trading in-the-money options near expiration because they have very high deltas. On the flip side, however, delta of an OTM option contract will approach zero near the expiration.
Delta also measures the probability of an option contract expiring in-the-money or out-of-the-money. An at-the-money option normally has a delta near .50 because there's a fifty-fifty chance that the contract will be ITM or OTM at the expiration. As the options moves in-the-money, the delta increases because the probabilities are getting better that the contract will be ITM at the expiration. Deep OTM options have low deltas. For example, with BAC at $13.61, an April 16 call, which expires in nine days, has a delta of only .015. There's a 1.5% chance that Bank of America will be trading above $16 at the end of next week... and a 98.5% probability that it won't.
Experienced options traders use delta to gauge the probability of a contract expiring ITM and also to calculate the potential changes of, not just a single contract, but more advanced positions as well. For example, you can calculate the position delta of a vertical call spread by subtracting the delta of the short call from the delta long call. Doing so gives you a sense of how the position will perform when the underlying stock makes its next one point move higher or lower.
At the time of publication, Fred Ruffy held no positions in the stocks or issues mentioned.
Frederic Ruffy is an experienced trader and provides daily commentary and analysis of the options market. He is co-founder of the web site, WhatsTrading.com. His work has also appeared in Futures Magazine, Technical Analysis of Stocks & Commodities, Stock Futures and Options, and Sentiment.
In addition to writing market commentary and trading-related books and articles, Fred has also worked as an instructor, educating investors on advanced topics like measuring volatility, the benefits of sector rotation and the risks and potential profits from trading around earnings. An active trader himself, with over 15 years securities industry experience, his market observations and analysis of the options market are featured regularly in the financial press including Barron's, Reuters, The Wall Street Journal, and Bloomberg.
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