Now that we have covered the basics of options, it is important to understand how they act. The main terminology behind their behaviors take us back to high school physics, where we utilize the Greeks: delta, gamma, theta, and vega (not really a Greek letter, but it works).
This time, we will focus on delta!
Options: Delta
The delta is a theoretical number that measures how much the value of the option will change if the underlying stock moves up or down $1.00. A positive delta means that the option position will rise in value if the stock price rises, and fall in value if the stock price falls (usually a call). A negative delta means the opposite, that the option value will rise with a decline in the underlying stock price (usually a put). The delta can range from 0.00 to 1.00 for a call, and 0.00 to -1.00 for a put. The closer to 1.00 or -1.00, the more the price of the option responds like the underlying stock. However, this assumes that nothing else changes – such as volatility, interest rates, or time. Any of these can change delta even if the price of the stock remains the same. Also, the more ATM the option is, the closer its delta is to 0.50. The more ITM, the closer to 1.00, and the more OTM, the closer to 0.00.
On the Thinkorswim platform, delta is presented in terms of shares of stock, with 1 call representing 100 shares of stock. So if delta is +.75, the platform will show a delta of +75. In our example below, the Sept10 1090 call has a delta of 54.08, which really would be +.5408.
So, as of 8/18/10, the Sept10 1090 call has an ask of $26.80. If we would buy that call at $26.80, the delta would be +.5408. The current underlying price is $1,094.16. Theoretically, if all else is the same (volatility, interest rates, dividends, and time), if the price moved to $1095.16, the price of the option should move to $27.34.
Also, you can see, that as the option moves more into the money (as illustrated by the +5% hypothetical), the delta increases closer to 1.00.
So delta is an important measure because it is a gauge of how much your option will gain in value given underlying stock changes relative to the strike price.
ThinkorSwimSPXSept10
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This post was written by...
Robert – who has written 317 posts on The College Investor.
Robert is the founder and editor of The College Investor, a personal finance site dedicated to young adult and college student finances. You can learn more about him here and connect with him on Twitter or Facebook.
