In the last post I talked about the importance of delta and gave a basic example. I also posed a question: a stock at 50 moved to 51, and its 2-month 50 strike call moved from $3 to $3.50. At the time, the delta was $0.50, explaining the move in the options price from $3 to $3.50.

Now based to the cliffhanger question, the option is trading at $3.50 and the stock is at 51, what do you think the option will be trading for if the option goes from 51 to 52? Will it move 50 cents again, or more or less than that?

The answer is more than 50 cents. The option should be trading for about $4.10, which means it moved about 60 cents. Delta is dynamic, so how close or how far away the stock is from the strike price determines how the option will react to the stock price movement. When we started out the option had a delta of   .50,  which meant if the stock went up one the option should go up about 50 cents - 50% of the stock's movement. When the stock was trading at 51, the option's delta was .60, so when the stock made the next point move, the option moved about 60% of the stock price movement.

This illustrates a useful rule-of-thumb about delta. At-the-money (ATM) options usually have a delta of around 50 cents, or traders will often remove the cents and just say the delta is 50 (which is the convention I will use). In-the-Money (ITM) options have deltas between 50 and 1, never larger than 1; and out-of-the-money (OTM) options have deltas between 50 and 0, obviously never going below 0.

ATM - Delta close to 50
ITM - Deltas between 50 and 1
OTM - Deltas between 50 and 0

Below is a chart of actual deltas derived from the TradeKing option chains.

In the next post, let's move on to another question: how can we use delta to predict option's price movements as they approach expiration?

Regards,
Brian (OG)

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

While Delta represents the consensus of the marketplace as to the theoretical price movement of the option relative to the underlying security there is no guarantee that this forecast will be correct.

I am reading your blogs to learn about options but what I don't know is how/where do you find out when the calls are? Are they the same for every option? When investing, what does the option price mean in reguards to the stock price...when I buy them. Thanks for the help.

Hi Chrissy, Check out Yahoo finance; they have a great education section on learning options basics. That is where I began. I still have a tremendous amount to learn but the material had some nice examples.