An option delta measures the change in the price of a stock option relative to the change in the price of the underlying stock. If an option increases $.50 and the stock increases by $1, the Delta is .5. Put options have a negative delta. Delta belongs to a group of option measures called “the Greeks”. Deep in the money options have a Delta close to 1 and they trade in tandem with the underlying stock. In the money options with very little time to expiration also trade at parity and they have a Delta of 1. Out of the money options have very low Deltas because the stock has to travel a great distance before it starts picking up intrinsic value. LEAP options also have lower Deltas because they carry a huge time component. Options with high implied volatilities also have lower Deltas. In short, if you are looking for a consistent, grinding move, choose an option with a high Delta so that you can take profits as the stock moves in your favor. The price of the option will be higher, but you feel confident that you will not be blindsided because the stock has a predictable price pattern. If you identify the potential for a large move but the probability is lower, you might opt for a lower Delta. If the move materializes, it will be big enough to move through the strike. If it does not materialize, you won’t have paid much for the option.
December 30, 2008