May 30, 2012 , , admin

Options Delta : The Basics

options, call, put, hedging, risk , return, delta, delta neutral strategy, options basics, enrichwise
Options Delta is the ratio of the change in the price of the stock option to the change in the price of the underlying stock
Delta = instantaneous change in value of asset with respect to an underlying risk factor. Option’s delta changes continuously as underlying risk factor changes
Here are some basic characteristics of Options Delta :

  • It is the change in the price of an option for a one point moves in the underlying
  • Delta of a call option is positive
  • Delta of a put option is negative
  • Delta increases – in decreasing index
  • Delta decreases – in increasing index
  • Call options: 0 < Option Delta < 1
  • Put options: -1 < Option Delta < 0
  • In-the-money options: Delta Option approaches 1 (call:+1,put:-1)
  • At-the-money options: Delta is about 0.5 (call:+0.5, put: -0.5)
  • Out-of-the-money options: Delta Option approaches 0
  • Call Option Delta can be interpreted as the probability that the option will finish in the money
  • An at-the-money option : which has a delta of approximately 0.5, has roughly a 50/50 chance of ending up in-the-money
  • Put Option Delta can be interpreted as -1 times the probability that the option will finish in the money

Impact of Time : As time passes, the delta of In-the-money options: increases & Out-of-the-money options: decreases
Impact of Volatility : As volatility falls, the delta of In-the-money options: increases & Out-of-the-money options: decreases
Hedging using Options – Delta to neutralize market risk :

  • In order to maintain a riskless hedge using an option and the underlying stock, need to adjust holdings in the stock periodically
  • An important parameter in pricing and hedging of options
  • No. of units of stock should hold for each option shorted in order to create a riskless hedge
  • Construction of a riskless hedge is sometimes referred as delta hedging

To get more information on Options Greeks , read Options Basics of Vega ,  Gamma 
“The greatest ignorance is to reject something you know nothing about”…If you are invested in Markets, it makes sense to be aware of & have an idea about Options. 

Tags:

Leave a comment