Futures and options trading may seem complex but can be beneficial when done strategically. Before you can start to undertake F&O trading, it’s important to know about the metrics you can look at to correctly assess these derivative contracts. When it comes to options trading, there are a set of risk assessment metrics that are called the Option Greeks. They are named so because these metrics are named after the letters in the Greek alphabet and are delta, gamma, theta, and vega. In this article, let’s dive deep into option delta.
What is option delta?
An option contract has an underlying security such as a stock, index, etc. whose pricetends to fluctuategiven the volatile nature of the market. Delta measures how the option’s price or premium changes in response to a price change of its underlying asset. Hence, delta essentially measures the price sensitivity of the option relative to its underlying security.
Delta can be expressed on a scale of -100 to 100 or -1 to 1. Considering the latter, for call options, delta is between 0 and 1 and for put options delta is between –1 and 0. Put options have an inverse relationship with the premium of the underlying security – when the price of the security rises, the option premium falls. Hence, put options have a negative delta. Contrary to this, call options have a direct or positive relationship with the price of the security – as the price rises, so does the option premium. This is only if there are no changes in other variables such as the time until expiration.
Why is delta important?
Let’s understand how delta shows the price sensitivity of an option with the help of an example. Say, the price of the underlying stock of a call option with a delta of 0.5 rises by Rs. 40. In that case, the price of the option will increase by Rs. 20. But if this was a put option with a delta of –0.5, then the price of the option would fall by Rs. 20.
The option Greek delta is also helpful in determining the directional probability of the option. In options trading, an in-the-money (ITM) call option means that the holder can buy the security at a price lower than its current market value. While an in-the-money put option means that the holder can sell the security at a price higher than its market value.
What delta does is that it helps you assess whether the option will end up in-the-money at its expiration. For instance, if you buy an out-of-the-money call option that has a delta of 0.4, then that would mean that roughly it has about a 40% chance of being in-the-money at the time of expiration. It’s important to keep in mind that the delta of an option tends to increase the closer it is to expiration for at-the-money options.
The delta of an option is influenced by several factors such as market volatility, the time to expiration, etc. and it keeps changing. Gamma, another one of the option Greeks,is used to measure the rate of change of delta over time. Simply put, gamma helps evaluate the stability of the option delta. Using the option Greeks of delta and gamma can help you build and execute your trading strategy effectively.
Smriti Jain is the owner and senior content publisher at Financesmarti. Financesmarti is a website where she shares a lot of useful stuff for the people and business of India. This includes small business ideas and other banking information, as well. Smriti completed her education in science & technology from Delhi University. Smriti usually has interests in digital marketing now, and she has chosen this career for the full-time opportunity. The primary purpose of starting this blog to provide quality information on the banking industry to the people.
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