Top Four Uses of Delta
Top Four Uses of Delta
By:Josh Fabian
Delta is arguably the most important and most often discussed option risk metric. Delta can tell us a lot about our positions and portfolio. There are four main uses for delta we all should understand.
Directional bias
Deltas communicate the amount an option’s price will change when its underlying stock’s price changes $1.00, and are expressed as either positive or negative numbers. Positive delta has a bullish directional bias while negative delta expresses a bearish bias. If we buy an option with a delta of .25 that means for every $1 the stock moves, the option will move $0.25. The inverse is also true. If the stock drops $1, the option will drop $0.25.
Share equivalency
Another way we use delta is to understand the equivalent number of shares an option represents. That option with a .25 delta is equivalent to owning 25 shares of the underlying. Therefore, if we want to use an option as a stock equivalent, we can do so by looking at delta. If we are long 75 shares of stock and want to increase that position to 100 shares, we might look to sell a put with .25 deltas or buy a call with .25 deltas.
Options needed to delta hedge a stock position
It makes sense if delta expresses share equivalency that it also works for hedging. One share of stock has one delta. A position of long 75 shares of a stock can be hedged against a drop in the stock’s price by purchasing a put with a .75 delta. Combining stock with option delta allows us to create hedges against individual positions and portfolios as a whole.
Probabilities of market move
The fourth way we use delta is as a measure of probability. Delta is an approximation of the probability an option will be in the money at expiration. An option with a .25 delta has a 25% chance of being in the money at expiration. If we sell an option with a .25 delta, that means we’re looking at a 75% chance that this option will not be in the money at expiration.
Delta is a dynamic number when it comes to understanding our market exposure. It allows us to view positions in terms of direction, shares of stock, hedging and probabilities. We spend a lot of time discussing delta because of the many things it communicates about our trades.
Josh Fabian has been trading futures and derivatives for more than 25 years.
For more on this topic see:
Options Jive | Top Four Uses of Delta: May 10, 2016
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastylive content is created, produced, and provided solely by tastylive, Inc. (“tastylive”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, digital asset, other product, transaction, or investment strategy is suitable for any person. Trading securities, futures products, and digital assets involve risk and may result in a loss greater than the original amount invested. tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastylive is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer. Options, futures, and futures options are not suitable for all investors. Prior to trading securities, options, futures, or futures options, please read the applicable risk disclosures, including, but not limited to, the Characteristics and Risks of Standardized Options Disclosure and the Futures and Exchange-Traded Options Risk Disclosure found on tastytrade.com/disclosures.
tastytrade, Inc. ("tastytrade”) is a registered broker-dealer and member of FINRA, NFA, and SIPC. tastytrade was previously known as tastyworks, Inc. (“tastyworks”). tastytrade offers self-directed brokerage accounts to its customers. tastytrade does not give financial or trading advice, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastytrade’s systems, services or products. tastytrade is a wholly-owned subsidiary of tastylive, Inc.
tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. tastytrade and Marketing Agent are separate entities with their own products and services. tastylive is the parent company of tastytrade.
tastycrypto is provided solely by tasty Software Solutions, LLC. tasty Software Solutions, LLC is a separate but affiliate company of tastylive, Inc. Neither tastylive nor any of its affiliates are responsible for the products or services provided by tasty Software Solutions, LLC. Cryptocurrency trading is not suitable for all investors due to the number of risks involved. The value of any cryptocurrency, including digital assets pegged to fiat currency, commodities, or any other asset, may go to zero.
© copyright 2013 - 2024 tastylive, Inc. All Rights Reserved. Applicable portions of the Terms of Use on tastylive.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastylive’s podcasts as necessary to view for personal use. tastylive was previously known as tastytrade, Inc. tastylive is a trademark/servicemark owned by tastylive, Inc.