Long Option Traders Can Sell Underlying Stock

Let’s retrain your brain to think of options just like the underlying stock. I’ve trained over 1000 options traders and I’ve found this to be the simplest way to understand options contracts.

Options are a derivative of the underlying stock they represent. Let’s go through an example:

$ABC trading at $10.

For this example, let’s buy 10 ABC calls for $.50.

Risk is $500 (can never lose more).

Delta of the $10 strike calls = $.50.

First lesson: The delta of the “at-the-money” options is usually darn close to $.50.

If we use delta as the likelihood a position ends up in the money by expiration, we can then interpret that delta:

• 50% chance to trade higher.
• 50% chance to trade lower.

Notice the delta in $SNAP?

These options expire in 155 days. The delta of the $23 and $24 strikes are $.62, and $.59 respectively.  Because there’s so much time in the above $SNAP options, all deltas are somewhat close to $.5.

Back to our $ABC example: Our delta exposure in $ABC will be 500 shares of stock.

Why 500? 

1 option contract = 100 shares of stock. 

Long 10 calls that expire in-the-money is the same as being long 1000 shares. If a market maker wants to trade ABC “delta neutral,” what does he need to do?

He needs to find 500 deltas to sell. Right?

Where to find short deltas?

• Sell $ABC shares
• Sell $ABC calls
• Buy $ABC puts

Fun note – selling calls will not only get us closer to delta neutral, it will also get us closer to “volatility neutral.”

For this example, let's sell 500 shares of $ABC.

New position:

Long 10 Calls in ABC (.5 delta)

Short 500 Shares

Big News Hit the Wires!

$ABC won the lottery, $ABC stock skyrockets to $30! What happens to our position?

Long 10 Calls are now worth $30 – $10 = $20,000 less $500 paid = $15,000!

Short 500 Shares = <10,000 >

The delta on our long calls jumped to 1 after the news. With the stock trading at $30, those $10 call options are now trading with the risk profile as holding $ABC stock from $10; no difference.

That's why the delta is 1.

How are we doing? What's the delta of the $10 strike puts?

Let us know in our Discord channel.