it's been a while since I posted here so I thought I would give the newbies some options education..
This topic is What is ‘Delta’ and Why is the Delta Important?
1.What is ‘Delta
In simple terms, the Delta of an Option relates to the amount the Option price changes, in relation to the amount of movement in the price of the underlying security (share). In general, an Option Contract that is deeply In-the-Money will have a Delta of 1. This means that for every point of movement in the price of the underlying security, there will be an equal movement in the price of the Option contract.
For example; ANZ is trading at $13.50 and you are looking at a Call Option with a Strike Price of $11.00. As you are aware, that contract is deeply In-the-money because it allows you to buy the shares for $2.50 below the current market. This contract is likely to have a Delta of 1, meaning for every cent of share price movement, there will be an equal amount of option contract price movement.
Conversely, an Option which is deeply Out-of the-Money will have a Delta of 0. This means that once an option contract has past a certain point, it can no longer move with the share price. This is not an indication that it cannot recover. If the underlying security turns and moves in a favourable direction, the contract and the Delta will adjust accordingly.
At a glance, if an option is In-the-money the Delta will be around 1, if it is Out-of-the-money, the Delta will be around 0 and if it is At-the-money it will be around 0.5. Most Options will lie somewhere on this scale.
(Put Options are the same concept, however, the Delta will be referred to as a negative figure or 0 to –1.)
2.Why is the Delta Important?
The Delta can be used to judge profitability of a trade. One thing to remember, is that the Delta of an option is linked to an underlying security and they are dynamic and forever changing. For this reason, the Delta should not be used as a decision making tool, but more as a profitability guide, once the decision has been made.
There are many other formulas in the family of ‘Greeks’. There are thetas, gammas betas etc. For me, trying to remember the names is an arduous enough task without trying to discover when to use them, or what they do. The KISS principle couldn’t be more valuable than it is in trading. If you find you need to re-analyse every trade you make time after time, you will find you are attempting to trade using “left” brain logic only and one thing the market is definitely not - is logical.
Generally, in a Call situation, the higher the Delta, the more likely the price of the option is likely to rise, in accordance with the price of the underlying security. Likewise, in a put situation the larger the number, the greater the effect on the rise in the option price. (The reason I say the larger the number is because put options are measured using a negative delta.)
For Example: A Delta of 0.80 indicates that for every $1.00 rise in share price, the option price will rise 0.80 cents, but don’t get trapped into believing that the highest Delta is the best investment.
While Delta is an indication, personally I never use it as an entry or exit guide due to it’s volatility. Working out the Delta is like painting the Sydney Harbour Bridge. Once you have given it your consideration, it has changed so you need to reconsider it again. There are much easier and faster ways to select the most profitable contracts.
Hope you enjoyed the post and if you did not know about the delta in options ...well now you do