Markets are closed tomorrow for the Fourth of July holiday.
Usually on days before a holiday, trading volumes and dry up, and volatility drops…leaving very few if any trading opportunities on the day.
Of course, there is that chance a catalyst hits, so I’ll be at my desk, but I’m not expecting to do much.
Instead, I’ll probably be reviewing trades and working on new trade ideas.
(Gotta love options! And you gotta love Sniper Report for these finds)
I didn’t start trading options until my 3rd year as a trader, and although I have made plenty of money trading them, I still try to learn and develop new concepts.
Studies show that if you teach others it’s an extremely effective way to learn. And that’s what I’m going to do with you now. I’m going to give you an options lesson, this one is on the options Greek, Delta.
Why You Need to Take into Delta When You’re Trading Options
If you don’t know, there are a few factors that affect an option’s price. Well, there are simple tools, known as options greeks, that let us know how sensitive an option’s price is to an underlying change.
One key option greek, or sensitivity, to take into account is delta.
Now, Delta simply measures how sensitive an option is given a $1 move in the underlying stock.
When you’re trading options… whether they be puts (bearish bets) or calls (bullish bets), understanding how Delta works will be beneficial to your trading.
How?
It lets you know how much your PnL for an options position will change as the underlying stock moves.
Now, you probably know that when you buy an option, there is a strike price and expiration date… now the strike price you select will actually dictate where the Delta is.
If you don’t know, there’s something called “moneyness” with options. Basically, this tells us where the strike price is in relation to the stock’s current price.
- Out-of-the-money (OTM) options are those with strike prices far away from where the stock is trading.
- In-the-money (ITM) calls are those with strike prices lower than where the stock is currently trading. In other words, these options have a lot of value and will be affected by underlying stock moves.On the other hand ITM puts are ones where the strike prices are greater than where the stock is currently trading.
- At-the-money (ATM) options are those with strike prices very close to the stock’s current price (typically the strike price is within a few points of the current stock price)
Now, depending on which options you buy the Delta will vary. Now, for call options, the Delta will be between 0 and 1. On the other hand, for puts, the Delta will be between -1 and 0.
There’s one thing to keep in mind about Delta… the value is not static and will change with the stock price.
A Look at How Delta Moves for Call Options
Here’s a look at the options chain for Apple (these options expire in about a month).
Currently, Apple (AAPL) is trading above $200. Now, if you look at the left-hand side of the options chains, you’ll see a blue rectangular area.
Well, those are the deltas for the call options. As you can see on the top row for the calls with a strike price of $182.50 the Delta is very close to $1. These are considered deep ITM calls.
Now, with the $182.50 strike price calls (the first row)… those options will trade a lot like stock.
You see, for every $1 move, those call options will move around $1. For example, if AAPL rises by $1, those options will rise by $0.99.
Think about it like this… if you buy 100 shares of a stock and it moves up $1 from your entry, then your profit and loss (PnL) will go up by $100. On the other hand, if the stock falls by $1… you would be down $100 on that position.
So if you owned 1 contract of those options… for every $1 move in AAPL, your PnL will fluctuate by about $100.
There are some traders who actually use deep ITM options as a more cost-efficient way to trade stock. For example, if you’re trading expensive stocks like Apple (AAPL), Amazon.com Inc (AMZN), Alphabet (GOOGL)… it’ll cost you a lot just to buy 500 shares.
However, if you buy 5 deep ITM calls… it controls the same amount of shares, but is a lot more cost efficient, as those options will just cost a fraction of the price.
Now, when as you start to get farther OTM for these calls, you’ll notice the Delta gets closer and closer to 0.
For example, if you look at the last row and the left-hand side, the $220 strike price call options have a Delta of about 0.19.
In other words, if the stock moves $1, those calls will gain by around $0.19… but if AAPL falls by $1, those options would lose $0.19.
Here’s a look at how Delta for call options move in relation to the stock price.
ATM calls have a Delta around 0.50… and again, as you get deeper ITM, those calls will get closer to 1.00. On the other hand, as you go further out of the money, the Delta will get closer to 0.
Moving on.
The Delta for put options is just the inverse of the call options.
How Delta Moves for Put Options
Here’s a look at how Delta for puts move.
Remember, puts vary between -1 and 0.
For example, here’s a look at the options chain in AAPL again, this time we’re looking at the right-hand side (the put options).
If you look at the last row, these are considered deep ITM put options.
In other words, these options have value, as the strike price is significantly above the current stock price.
Now the $222.50 put options have a delta of -0.80.
You see, with puts… you want the stock to go down. So if AAPL falls by $1, those options will gain by $0.80, or -0.80 * -$1. On the other hand, if AAPL rises by $1, those options would lose $0.80 in value, or -0.80 * $1.
As you move up the rows, you’ll notice the Delta for the puts get closer and closer to 0. For example, if you look at the top row (the $182.50 strike price puts), the Delta is just -0.10. In other words, underlying changes in the stock price don’t really affect those options.
Pretty straight forward right?
The key takeaway is just to know what your Delta is for an options position and know how it’ll affect your PnL. Remember, the Delta is not static and it will change as the underlying stock price moves.
Now, if you’re interested in learning more about my trading style and find clarity in the markets, then click here to find out more.
[Ed.note: Kyle Dennis runs BiotechBreakouts.com. He is an event-based trader, who prefers low-priced and small-cap biotech stocks.Source: BiotechBreakouts.com | Original Link