Option traders are often speaking another language. I want to help you understand how your option’s value is going to be affected by changes in the market. We can calculate how our option is going to react to these changes by understanding the Option Greeks. The Black-Scholes Model identifies 5 Option Greeks to help us forecast the value of our option (Delta, Gamma, Vega, Theta, and Rho). These Greek’s will help identify our option’s reaction to changes in the price of the underlying futures contract, time decay, volatility, and interest rate. In this article we are going to explore the Delta.
Delta is the measure of the degree to which an option is going to move relative to the underlying futures contract. In other words, it is a measurement tool to find out the speed the option value will change in relation to a full point move in the underlying futures contract.
For example let’s look at crude oil:
If my option has a delta of 0.50, this means that for every $1.00 move in the crude oil futures, my option will go up or down by $0.50 (1.00*0.5=0.50). In other words, my option’s value will fluctuate approximately half the rate of the actual futures contract. So if crude oil were to move $3.00, my option value would change by roughly $1.50.
The higher the delta, the more sensitive the option is going to be to the underlying futures contract. The options distance from the current market price, as well as the number of days left until expiration are two factors that will determine the options delta.
Call Option Delta
For call options, the delta can range from 0 to 1. A one delta would mean that the option is going to fluctuate tick for tick with the futures. A zero delta would mean that the options value is not going to be affected by the movement in the underlying futures contract. That being said, the deeper in-the-money an option is and the less amount of time the option has until expiration, the closer the delta is going to be to one. The further out of the money and the more time an option has until expiration, the closer the delta is going to be to zero. An at-the-money option will have a delta of around 0.50 because there is a 50% chance the option can move in-the-money, and a 50% chance the option can move out-the-money.
Put Option Delta
Put options, on the other hand, will have a negative delta, but the same rules apply. Deep in-the-money puts will have a delta closer to -1, and far out-the-money options will have a delta closer to 0. At-the-money puts will have a delta around -0.50.
Every trade begins with an idea. Whether you are hedging or speculating in the markets, understanding your positions delta will give you a clearer picture on how your trade is going to react to price fluctuations. Your delta, accompanied with the rest of the option Greek’s will help you more accurately forecast your options value and properly manage your position.