August 6, 2018

What Every Option Trader Should Know About Delta

Delta is the sensitivity of an option’s price with regards to the movement of the related underlying future or security. It is expressed both as a percentage and a total. A call option with an estimated 25 delta suggests that the call option is one-quarter as sensitive as compared to the corresponding underlying. It implies that you would need 4 25 delta options to replicate the performance of a one-point move in the underlying.

• Professional traders think of an option’s delta as a hedge ratio; to what extent the option offsets or emulates the underlying. Professional traders learn very quickly that an option’s delta is only useful for a fractional move within that precise snapshot of time which it is calculated. An option’s delta can and does lose its relevance when there are changes in time, movement, and implied volatility.

• From a pedestrian viewpoint, it appears logical to envision an option’s delta using a simple equiprobable decision tree (i.e. a 50% chance of either an up or down move in the underlying) to price a call option. Yet this mind thought is dangerously flawed due to the conceptual problem of linking the resultant delta value with a probability.


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