Most traders have heard of delta -- it's probably the most widely quoted of all the Greeks. But knowing how useful it can be is something else. 

One of the biggest mistakes new options traders make starts like this: buy a call option and see if you can pick a winner. After all, it seems like a good place to start. Buying calls maps to the pattern you're used to following as an equity trader: buy low, sell high, in that order.

Options are trickier, though. Sometimes the underlying stock moves in the expected direction, but the option doesn't. Options with different strikes move differently when the underlying price moves up and down, and as the option approaches expiration. Is there any mathematical way to predict how much your option will move as the underlying moves?

The answer is delta -- it's the key to understanding how and why an option moves the way it does.

Delta is defined as the amount a theoretical option's price will change for a corresponding one-unit (point) change in the price of the underlying security -- assuming, of course, all other variables are unchanged.

Let's start with a basic, real-world example:

Say a stock is at 50 and we're looking at a 2-month call option with a strike price of 50 -- an at-the-money option whose current price is $3. If the stock goes from 50 to 51 right now, so the only thing that changes is the stock's price,  how much would you expect your option contract to move?

Don't look at the answer! Guess!

The option should move about $.50, to $3.50. How did I know that? I knew the option's delta, $0.50.  By the definition above, if the stock goes up $1, the option should go up roughly by the amount of delta. Hence, it should go from $3.00 to about $3.50.

But what about if the stock moves from 51 to 52? Will the option move another $0.50? Send me your comments...we'll settle this in the next post and discuss a critical rule-of-thumb for delta as it relates to moneyness.

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 view delta as a risk/reward factor. An ATM option has a 50/50 chance of expiring ITM, thus a delta of 50. The further ITM it moves the higher the odds and delta. Obviously time decay and/or volatilitycan wipe out a profit, but that doesn't change the odds of it finishing ITM.

That comment is 99% dead on. The only point I would argue is in regards to the volatility and time decay changing the odds and hence changing the delta. If the volatility of the underlying increases or decreases the odds of an option finishing in the money will increase or decrease, hence the delta will be affected. It will have a larger effect on the way in or out of the money options, but all the option contracts will be affected in some way shape or form. I will go into greater detail on this concept in the next post. Regards, Brian OG

The more in the money the option is, the more intrinsic vallue the option will have therefore as the option goes deeper into the money, the closer delta will approach 1.

Yes, in general, the more in the money the option is, the larger delta becomes and will eventually approach 1. But that is not what my comment is about, it is about how in increase in volatility would change the delta of the option contact. The implied volatility number does adjust the delta of an option contract. This means, if you are looking at an option on a stock with a very large implied volatility you will have to look much deeper in the money to find an option with a delta of 1 then you would have to on a stock with a low volatility. There is a relationship to Delta and volatility and there also is a relationship to Delta and expiration. Regards, Brian OG

What does this mean

Cubs

yes it will increase .50p i.e., $4.00

If ATM delta is 0.5, when is ITM delta increses. Perhaps not much, but I expect to some 0.55. So, for another dollar, there'll be some $0.55 extra.