Over the past several weeks, I have been working on writing my PowerPoint presentations for our annual option training retreat. Of course, I am reminded of several topics I need to focus on during the retreat but also in my daily lessons with traders. Management has always been priority number one for me, but I also put a great deal of focus on option delta. Let’s take a quick look.
There are several definitions of delta, and they are all very good. The one I’ll focus on here is that delta is the rate of change of an option based on the underlying. To keep it simple, for every $1 the underlying moves, the option premium should change by the amount of delta. Essentially there are only four things you can do with options: buy a call, sell a call, buy a put and sell a put. Long calls and short puts have positive deltas and can benefit from a move higher in the underlying. Short calls and long puts have negative deltas and can benefit from a move lower in the underlying. Think of delta as more of a bullish trade for positive and more of a bearish trade for negative.
If you have on more than one position at a time for the same strategy, then you need to total up the deltas. For example, if you bought 2 long calls each with a positive 40 delta, the position would have a positive 80 (40 X 2) delta overall. For a spread position, if your positive delta total is bigger than your negative delta, a move higher will benefit the position whether it is a debit or credit spread. If your negative delta total is bigger than your positive delta, a move lower will benefit the position. Simple and easy to remember.
Delta Made Easy
One more thing. I always teach this lesson to my one-on-one coaching students in our very first session. I like to say calls and puts will react the same way depending on the underlying. What I mean is that call option premiums and the deltas will always increase (keeping everything else constant) if the underlying rises and vice versa. Put option premiums and the deltas will always increase if the underlying falls and vice versa. Many option traders get confused on what is positive and what is negative, so to me this is an easy way to remember how the premium and delta will change. Obviously, whether you benefit from the move depends on if you are positive or negative.
There is a lot more to delta, of course, but these key points can help you understand delta and the significance of it on every position you take.
An option trader notices AAPL is holding a bullish base and it looks like it wants to break higher. He decides to buy a June call with 36 days to go till expiration to profit from the expected move higher. He buys the 175 call and pays 4.60 (as seen below).
Senior Options Instructor