Quick Trading Lesson to Start Your Monday

Delta is one of four major risk measures used by options traders. 

The other measures are gamma, theta, and vega. Rho is another, but even when rates move rho still has little effect on options. 

Delta measures the degree to which an option is exposed to shifts in the price of the underlying asset (i.e., a stock) or commodity (i.e., a futures contract). Values range from 1.0 to –1.0 (or 100 to –100, depending on the convention employed).

Delta is Simply the Probability an Options Strike Trades In-the-Money by Expiration.

Let’s go through an example:

• ABC stock is trading at $10
• ABC 10 strike delta = .5
• 10 days until expiration

 If we use delta as the likelihood a position ends up in the money by expiration, we can interpret that .5 delta as:

• 50% chance ABC stock trades higher
• 50% chance ABC stock trades lower

What would the delta of a deep-in-the-money call be with only a few days until expiration?

• ABC 2 strike calls delta = 1
• ABC 2 strike puts delta = 0

If we use delta as the likelihood a position ends ITM:

• 100% chance 2 strike calls finish in-the-money
• 0% chance the stock drops below $2 before the expiration

Let’s do a trade!

• Buy 10 strike calls 10x for $.50
• Risk = $500 (we can never lose more)
• Delta exposure = long 500 shares

Why 500? 

1 Option Contract = 100 shares of underlying stock.  

10*.5 = 500 shares

Buyer is long 500 deltas, seller is short 500 deltas.

Market makers (sellers in this example) do not want directional risk so they are forced to buy 500 deltas in order to hedge this trade “delta neutral” forcing the stock to trade higher in the short term.

This is the foundation of understanding Unusual Options Activity and why gigantic orders have a significant immediate effect on price.

Learn How to Spot Unusual Options Activity.