Asteria Essentials #4 - Options Delta

Hello Asterians,

Welcome to another Asteria Essential’s feature. If you’ve previously ventured into the rabbit hole of options, you probably must have heard about — “The Greeks.” And most of the time, that name is enough to extinguish curiosity and any further enthusiasm of diving deep into the realm of options. To save you from that misadventure, we’ll talk about one of the Greeks — Delta, but in a more fun and certainly in the least intimidating manner!

So without further ado, let’s get started, shall we?

Let’s Begin With the Very Basics — What the heck are the “The Greeks?”

In very brief and simple words, Greeks are the factors that influence option prices. A few of the Greeks are Delta, Gamma, Rho, and Theta. These are just four of the Greeks, and there are more.

Coming back to the Star of this blog post…

Delta — What is it?

Delta actually measures the sensitivity of an option.

Delta is the measure of the change in an options price that occurs when the underlying asset is changed.

For Put options, the value of Delta can range anywhere between -1 to 0. Meaning the Put option price is inversely proportional to the underlying asset’s performance. Hence, when the price of the underlying asset increases, the put option’s premium decreases, and vice versa.

For Call options, the value of Delta can range anywhere between 0 to 1. Meaning the price of Call option is directly proportional to the underlying asset’s performance.

Hence, when the price of the underlying asset increases, the put option’s premium increases, and vice versa (assuming all other factors remain constant).

We know it’s extremely hard to grasp just like that, let us explain in Asteria style.

Delta As an Example I

Let’s assume that there are two options — Option A and Option B, both of which have the same underlying asset.

Option A is an out-of-the-money option (underlying price is trading below the strike price) with a delta of 0.20;

Option B is an out-of-the-money option (market price is above the strike price) with a delta of 0.80.

Every $1 increase in the underlying asset price will result in a $0.20 increase in Option X premium and an $8.0 increase in Option Y premium.

Note that options with higher deltas are typically more in demand, which is why they are more expensive, especially when they’re potentially expiring in the money.

Delta alters as the option becomes more profitable (more likely to expire in the money- ITM). As the option gets close to ITM, delta nears a +1.00 on a call and -1.00 on a Put. Now, here the extreme ends begin evoking a 1:1 pattern between the option price and the changes in the underlying asset price.

In very simple terms, at delta value of +1.00 or -1.00, options begin to behave like the underlying asset. But this pattern occurs with little or no time value since most of the value is intrinsic.

Delta As an Example II

Let’s say you’re following Option X on a particularly fine day.

At 9:00 AM, you recorded that the Option X spot was at 8292. Sometime later…

You noticed a change in premium at 9:00 AM when Option X was at 8292, the call option was trading at 144, however when Option X moved to 8315 and the same call option was trading at 150.

And a little while later…OptionX depreciated to 8288, and so the option premium declined as well.

From the above patterns, it is very clear that as the price of the port changes, then the value of the premium also changes.

Keeping this in mind, imagine being able to predict that Option X would eventually land at 8355 by 5:00 PM. We have already seen that the premium will certainly change from the scenario above — but by how much? How likely it is for the value of Option X to go from 8250 to 8355.

This is exactly where the Delta of options comes into use. The Delta measures by how many points the option’s premium will change for every change in the underlying asset.

With any given strike price of an optionable stock, there is both a call and a put option available to trade. Meaning if you add the absolute values of the deltas of the call and the put together, you’ll get the number 1. For example, the call option has a Delta of 0.40, the put option for the same strike will have a Delta of -0.60.

This is almost always true, but it can be off slightly as you get farther away from the money in either direction. Even though it’s not perfect all the way up and down the option chain, the relationship of Delta between the call and put of the same strike is consistent. It also leads us to use Delta as a probability of expiring in-the-money.

This is because, at expiration, either the call or the put option will be in the money (with the exception of the rare case the stocks closes exactly on the strike at expiry). Therefore the sum of the probabilities should be 100% as the sum of the absolute values of Deltas should be 1.

Delta as a Probability

Takeaway from example I, Delta is most commonly used when determining the probability of an option expiring in-the-money. So an out-of-the-money (OTM) option with a 0.25 Delta has a near 25% chance of being in-the-money at expiration. It is assumed the option price follows a log-normal distribution.

Delta for Assessing Directional Risk

Takeaway from example II, Delta is also employed to determine directional risk. Positive Delta denotes long market sentiment, while negative delta are short assumptions.

Delta with higher values are considered ideal for strategies with high risk/high reward, and Delta with the lower value is suited for low risk/low reward strategies.

So when you purchase a Call option, you’d want it to have a positive delta since that means its price will increase with the underlying asset’s performance. In the case of a put option, you’d want a negative Delta since the price will decrease if the price of the underlying asset increases.

Scenario 1

There is an asset called Chad’Token (underlying asset), with a price of $5,312. The option is a call option, and we call it Option D, with a strike price of $5,400.

In this case,

The approximate value of Option D would be…anywhere between 0 to 0.5, but let’s say it is sitting at 0.4.

Let’s say Chad’Token appreciates from $5312 to $5,400, which means the Delta value rides up to ~0.5 since the Option D is ATM or at-the-money (strike price is equal to the present price).

Now, let’s assume that Chad’Token appreciates even more from $5,400 to $5,500. Since the option is now ITM or in-the-money (strike price is lower than the present price), then the delta value will be around 0.85.

Suddenly Chad’Token depreciates slightly, dipping to $5,200, then the option changes from ITM to OTM or out-of-the-money (strike price is higher than the present price), so the delta falls from 0.85 to 0.2.

It is clear from the above scenario that when the price of the underlying asset i.e. Chad’Token changed, the quality of option to be converted back to fiat also changed, causing the delta value to change as well.

Now you know how delta affects option price and its relationship with the underlying asset.

That will be it for this chapter of Asteria Essentials, and we’ll be back with a different one shortly.