Recognizing the Importance of Option Delta

Option delta can be the most important option Greek particularly if you like to make directional trades as an option trader. But I think you would be surprised about how people still struggle with this Greek. When I teach options, I always give a quiz, and more often than not, my students struggle with the details of delta.

Option Delta

Option 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.

If you have on more than one position at a time for the same strategy, then 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 easy to remember.

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 about 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 or not you are benefitting from the move.

Quick Example

If the 305 call were purchased (long), it would have a positive delta of approximately 0.30 (rounded up from 0.2992). So that means if the stock moved a dollar higher from $276.85 to $277.85. the delta would increase the premium to 8.05 (7.75 + 0.30) all else remaining constant. If the stock fell $2 to $274.85. the new premium would be 7.15 (7.75 - (2 X 0.30)) all else held constant. It is simple but can be confusing at times especially if the call option were sold or shorted. The position would then be negative delta, but the premium would increase or decrease the same (0.30 for every dollar move) as it did for the long call.

There is a lot more to it, but grasping these key points can help give you a better understanding of delta. And understanding the Greeks can help you understand how to manage your option trades so much better.

John Kmiecik, Market Taker Mentoring

Trader Education