Option vega and gamma are the option greeks many option traders feel are the most difficult to understand. Of course, that is debatable, but generally option delta is not high on that list. Just because many option traders feel they have a better handle on delta than other greeks, does not mean they have a good grasp of it. Let’s take a closer look at option delta.

Delta Defined

There are several different definitions of delta that option traders can use. The one I think is mandatory to know for most option traders 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.

Delta Example

Take a look at the example below. If an option trader bought the 175 strike call he or she would pay 8.15 (ask price). The position would have a positive delta of 0.63. So, if the underlying moved $1 higher, the ask premium should increase to 8.78 (8.15 + 0.63) based on the delta alone. If the underlying moved a $1 lower, the new ask premium would be 7.52 (8.15 – 0.63).

If you have on more than one position at a time for the same strategy, you need to total up the deltas. 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 in my opinion easy to remember.

Delta and the Premium

The last thing that has helped me and many others as far as delta goes is knowing how the premium and deltas will change. I like to say calls and puts will react the same way depending on the underlying. What I mean is that call option premiums will always increase (keeping everything else constant) as well as the deltas if the underlying rises and vice versa. Put option premiums as well as 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 and for me this is an easy way to remember how the premium and delta will change. Obviously, it just depends on if you are positive or negative delta whether you are benefitting from the move.

Finally

Understanding all the option greeks is critical for your potential success as an option trader. Delta is just one of the greeks and despite its simplicity, there is more to delta than meets the eye.

John Kmiecik, Market Taker Mentoring