#662 - Delta Of An Option Contract

The "Daily Call" From Option Alpha

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to be talking about the Delta of an option contract. Delta’s an incredibly important Greek for option pricing and for options traders in general. In fact, if you’ve listened to any of our podcast or watched any of our videos anywhere online over the last 10 years, you’ve probably heard me say that word, Delta a number of times and that’s because we use Delta as a good guidepost and reference for building out strategies and using different trading techniques. Now, what many people don’t know or they falsely assume is the reality, is that the Greeks are part of an option’s price, but the Greeks are actually not part of option pricing at all. The Greeks are only used to estimate what an option price might do in the future reacting to a specific market environment change. All Delta is trying to do is Delta is trying to basically tell us what amount of money the option contract will move based on an expected $1 move higher in the underlying stock. Again, Delta tells us how much the option price is going to move based on an expected, so not an actual, but an expected $1 move higher in the underlying stock. Now, this naturally means then that all call options have positive Deltas because as the stock moves up, then the value of all call options goes up across the chain. Put options have negative Deltas, so as a stock moves up, then the value of put options goes down across the chain and it starts to change and shift.

When we look for different strategies, we’ll be using in many cases, Deltas as our reference point. We might say we’re going to enter a 15 Delta strangle, so we sell the 15 Delta put option and the 15 Delta call option or we might do a 30 Delta credit spread, something like that. Again, it’s a very good reference to kind of use as a tool to get into a lot of similar positions across multiple underlyings with vastly different prices. But remember, the key for Delta is just the expectation of how much the stock might move in the future for a $1 move up. The way that I’ve also seen it explained which I think is really good is that Delta is basically the approximation of the number of shares that the underlying option contract is going to react like in the future. If you were to own an option contract, it really controls 100 shares of stock, right? But if you have an 80 Delta strike price on let’s say a call option, then that call option, even though you control 100 shares, is going to move like it’s 80 shares of stock. If you have a 70 Delta call option, it’s going to actually move like you just have 70 shares of stock. It’s not going to move like you have the full 100 shares, meaning if the stock goes up by $1, you’re not going to make $100, you might make $70 or you might make $80 in those scenarios. Hopefully this helps out. As always, we got a lot of training on Option Alpha on the different option Greeks. We did a long podcast on our weekly show which is Option Alpha’s weekly podcast, show number 44, so it was a long time ago, many years ago, but it was one of the first ones that we did in that kind of series, so if you want more information on the Greeks, check out optionalpha.com/show44. Again, that’s just the number, 44, optionalpha.com/show44 and until next time, happy trading.