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Options Delta Explained

Dec. 15, 2020 12:11 PM ETMSFT
Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

I’m Markus Heitkoetter and I’ve been an active trader for over 20 years.

I often see people who start trading and expect their accounts to explode, based on promises and hype they see in ads and e-mails.

They start trading and realize it doesn’t work this way.

The purpose of these articles is to show you the trading strategies and tools that I personally use to trade my own account so that you can grow your own account systematically. Real money…real trades.

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What is Delta? You see options prices are influenced by what they call the Greeks.

A few of the Greeks are Delta, Gamma, and Theta. These are just three of the Greeks there are more.

When you’re trading options, it is important that you know about the Greeks and what they do.

For this article, we will focus on Delta, what it is, and why you should know exactly what Delta is.

Then we’ll go through a specific example explaining it, and then I’ll share with you a few things that you need to know about Delta.

So let’s get started.

The Greeks

OK, so as I mentioned, there are the option Greeks. Here are a few of them and what they tell you:

1) Delta is actually measuring the sensitivity. It’s a mouthful, but I’ll show you exactly what it means, for the option’s premium relative to the underlying asset in this article.

In a nutshell, though, it basically says, how much does the option price change if the stock moves $1 to the upside or the downside?

2) Gamma is the rate of change of the Delta.

3) Theta, and Theta basically measures time decay.

What Is Delta?

So what is Delta? Delta is a number between 0 and 1 that measures how much the price of an option changes if the stock moves by $1.

I know all of this sounds super theoretical, so let me actually give you a specific example.

Now, the example that I want to use here is Microsoft (MSFT) when it was trading at $211.20.

I want to show you different strike prices of options, because, again, options have strike prices and expirations.

We are looking at the current price of this option and we will look at the new price of this option if Microsoft moves by $1 from $211.20 to $212.20.

When we bring up the option chain in our trading platform, in this case, Tastyworks, the option we are using as an example is expiring on November 27th.

So as you can see, there are different call options on this site with different strike prices.

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You can also see that they have all sorts of different Deltas. So let’s get started with the 205 that is right now trading at $7.30, and the Delta is 0.8. Remember, the Delta is 0.8 because again, the Delta is between 0 and 1.

I’ll tell you about negative Delta in just a moment. The current price of the option is what we are seeing right here. We look at the last traded price, the last traded price is $6.92.

So what does it mean? It means if Microsoft (MSFT) goes up by $1 to $212.20, that the new price is $6.92 plus the Delta ($0.80).

So, you see this where it’s really important that you understand Delta. Some people think that options move even more than the stock, and this is not true at all.

So option prices always move less than the stock price. So the new price here of the option would then be $7.72.

So this is for a strike price of 205, and this is a strike price that is so-called ITM “In The Money” because its value, its strike is less than the current price.

Now let’s take a look at a strike that is at the money.

Now assuming Microsoft (MSFT) is trading at $211 we will use the 210 strike price here.

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As you can see, the 210 strike price has a Delta of 0.57, and this would be a so-called ATM “At The Money” with a Delta of 0.57.

Again, it is between 0 and 1. The current price of the 210 strike here is $3.05. We are using the last traded price here.

So if Microsoft (MSFT) moves by $1 upwards, this option only moves 0.57. So this means that this option moves to $3.62.

I’ll show you one more example.

So we are using a strike of 215. So that would be OTM “Out Of The Money,” and the Delta is 0.27. So the current price of this option is $1.06.

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So if the stock moves up by a dollar, this option only moves up by $0.27.

Even though the stock moves up by $1, this only moves to $1.33.

Things You Need To Know

So let’s talk about the things you need to know.

Options that are ITM have a higher Delta then options OTM. So this means that ITM options move more.

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Now, if you go back to our options chain here, you see that the Delta for deep in the money options is 0.98.

So this basically means that if the stock goes up by $1, the price of this option goes up by $0.98, so the deeper in the money, the closer to $1 the price will move.

So options that are ITM are more expensive. This is where it’s important that you see that there’s a relationship between the Delta and the price.

The higher the Delta, the higher the price, because the higher the Delta, the more it is in the money.

As a rule of thumb, options ATM “At The Money” which are right where the strike price is right at the level where the current price is, are usually around 0.5.

Now, all this applies to call options. Now put options have a negative Delta which is between -1 and 0.

Well, the price of a put decreases if the option goes up. So the Delta for put options is all negative.

Now, put options that are ATM, are usually closer to one. And options that are OTM, don’t move a whole lot.

This is very important because some people just think,

“Oh, my gosh, I’m buying out of the money options because they are cheap. It is so much cheaper to pay $1.6 than $6.92.”

But they don’t really move a whole lot.

Now here’s a really cool tip that you might not have known. The Delta is a rough estimate of the probability of the stock price closing above the strike.

So here, you see with a delta of 0.8, it means that there’s an 80% probability right now that the stock will be above that strike price. If the Delta is 0.27, then that means there’s a 27% probability that the stock will be above that strike price.

So I think it’s kind of cool as an options trader to know this. So the Delta is giving you a rough approximation of how likely is it that the stock will be above or below the current strike price on exploration.

Now here’s the tricky part, Delta is not fixed. So the Delta changes as the price changes and here’s why.

right now, if, for example, Microsoft (MSFT) (trading at $211) goes up to 215, the current strike price of 210 is deeper in the money therefore, then the Delta will be higher.

So now you know what Delta is, how it influences the option price, and you see that this is important when you are trading options. If you think that this is cool stuff that you should share with your friends, feel free to share this video on Facebook, on Twitter, by email and I will see you for the next article.

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