The Power of Delta

When I first began trading, I had no idea what any of the Greeks meant. I was basically trading blind, looking only at probability of profit and max loss. When I started utilizing the Greeks, especially delta, trading began to make a lot more sense!

Delta is an awesome way to quantify your trade, giving you risk and directional metrics. Higher delta equates to more risk, and positive delta indicates a bullish assumption (and vice versa for lower and negative). So a trade with a low, positive delta would be a low risk bullish strategy.

In the bigger picture, delta also represents how much an option price will change given a $1 move in the underlying. So a delta of $0.40 of an option means that if the stock moved $1, the option will move up/down by $0.40.

Delta also tells directional exposure in terms of stock. So if we are looking to be delta neutral (a delta of 0), and buy 100 calls with a delta of 0.50, you would need to sell 5,000 shares of stock to hedge that position (100 contracts x 0.50 delta x 100 shares/contract). This is because 100 contracts is equal to 10,000 shares, so it would make sense to hedge a delta of 0.50 with half as many shares as the underlying.

A more simple use of delta is to use the delta of an option to estimate the likelihood that the option expires in the money. So a 0.50 delta option has a 50% chance of expiring at least $0.01 in the money, and a 0.25 delta option has a 25% chance, and so on and so forth.

Another important note is that call options will always have a delta between 0 and 1 because as the underlying increases in price, so does the call option. Put options, on the other hand, range from -1 to 0 because as the underlying increases, the value of the put option decreases.

So delta is definitely an important Greek to know! It has a lot of uses, which may seem intimidating at first, but eventually become second nature. Delta gives you the opportunity to learn how to hedge risk by understanding how an option price changes relative to the underlying, and the probability of the option expiring in the money.

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.

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