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RAVI - IBA
Delta
Deltais a theoretical estimate of how
much an options premium may change
given a $1 move in the underlying.
For an option with a Delta of .50, an
investor can expect about a $.50 move in
that options premium given a $1 move, up
or down, in the underlying.
For purchased options owned by an
investor, Delta is between 0 and 1.00 for
calls and 0 and -1.00 for puts
Delta
For sold options, as the investor
essentially has a negative quantity of
contracts, we find that short puts
have a positive Delta (technically a
negative Delta multiplied by a
negative number of contracts);
short calls have negative Delta
(technically a positive Delta times a
negative number of contracts).
Example
The XYZ 20 call has a .50 Delta and is trading at
$2 with XYZ stock at $20.50. XYZ rises to
$21.50.
The investor would expect that the 20 strike call
would now be worth around $2.50 as seen
below:
$1 increase in underlying price x .50 Delta =
$.50 anticipated change in option premium.
Original Premium: $2.00 + $.50 estimated
change = $2.50 estimated new premium after
$1 stock price increase.
Example Contd.
With a $1 move down in XYZ, the investor would
expect to see this same 20 strike call option
decrease in value to around $1.50.
As the stock price rises and the call option goes
deeper-in-the-money, Delta typically approaches
1.00 because of the increased likelihood the option
will be in-the-money at expiration.
As expiration approaches, in-the-money-option
Deltas are also more likely to be moving slowly
toward 1.00 because at expiration an option either
has a Delta of either 0 or 1.00 with no time
premium remaining.
Call Deltas range from 0.00 to 1.00 while put
Delta ranges from 0.00 to -1.00.
Remember long calls have positive Delta;
conversely short calls have negative Delta.
Long puts have negative Delta; short puts have
positive Delta.
The closer an option's Delta is to 1.00 or -1.00,
the more the price of the option responds (in
terms of dollars) to actual long or short stock
when the underlying moves.
Here is a quick chart for reference:
Calls havepositiveDeltas (as generated by
model)
Positive correlation to underlying stock price change
Stock price then call Delta tends to go up
Stock price then call Delta tends to go
Call Deltas range from 0 to +1.00
Puts havenegativeDeltas (as generated
by model)
Negative correlation to underlying stock price change
Stock price then put Delta tends to go
Stock price then put Delta tends to go
Put Deltas range from 0 to 1.00
Gamma
How Delta is expected to change
given a $1 move in the underlying is
calledGamma.
An investor can see how the Delta will
affect an option's price given a $1
move in the underlying, but to see
how the Delta on that optionmight
changegiven the same $1.00 move,
we refer to Gamma.
Gamma
Gamma will be a number anywhere
from 0 to 1.00. Since Delta cannot be
over 1.00, Gamma cannot be greater
than 1.00 either as Gamma
represents the anticipated change in
Delta.
Looking at a hypothetical example, XYZ is
trading 50. The XYZ Jan 50 call is trading for
$2, has a Delta of .50 and a Gamma of .06.
Should XYZ go up to $51, an investor can
estimate that the 50 strike call will now be
worth around $2.50.
The new Delta of this 50 strike call at an
XYZ price of $51 should be around 0.56
(simply adding the Gamma of .06 to the old
Delta of .50).
In other examples