What is Delta?

Hello, my name is Brian Overby.  I am the TradeKing's Senior Options Analyst, and author of The Options Playbook.  

I would like to address a question that I was recently asked today. The question is short. It is a fairly advanced question, but something that all option traders need to know. The question is:  What is "delta"?

And the answer for what delta is, first of all you have to kind of understand a little bit about how options are priced and what goes on in the options marketplace.  

First of all, an option is a derivative; it is derived from the stock's price. So basically, the price of a stock is what is helping determine the price of an option contract. And when something is usually derived from something else, that usually means that that contract that is derived from a different price will not act exactly like the underlying asset that the price is derived from.  

Okay, I said derived as many times as you possibly can in one sentence, but bottom line is, delta is a number that is provided by option pricing models that will give you a clue as to how much your option will move for 1-point movement in the underlying stock.  

So if I look at an option contract, and let's say the stock's at $50, the strike is $50, and the stock goes from $50 to $51. The question is, how much will my option contract move? And the answer to that question is, if I go in and look at what is the delta, if I see the delta is .50, that means if the underlying stock moves one unit, and most of the time that unit is 1 point, this gives me a hint as to, in theory, how much the option contract will be trading for.  

So if I go out and I look at this, and I have the stock at $50, the strike is $50, I see the call option is trading for $3 and when I say a call, that means I want the underlying market to go up. The stock goes from $50 to $51, I turn back, I look at my call option, my call option is now trading for $3.50. Well, how did I know? Well, I looked back at the delta, and before the stock moved I saw the delta was .50, which implies that if the stock goes up 1, my option contract should go up approximately fifty cents.  

Or another way that a lot of people will reference that is, they'll say the delta, and they'll truncate the cents and they'll say that the stock will move 50% of the stock price movement. So delta is often quoted as a percent of the movement, and it's also quoted as a number, as an actual cent movement of the underlying option contract.

Well, my name is Brian Overby.  I am Senior Options Analyst, and author of The Options Playbook. If you'd like to learn more, please check out tradeking.com, and check out our Trader Network, where traders network and share actual trades and performance. Also, there's an education center there where you can check out a plethora of information on all aspects of investing.