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When a new trader investigates the options arena, they are often overwhelmed by the new terms associated with options. The Greeks are a group of terms that are important to understand and that are often overlooked because they are new to stock traders. This week, we want to discuss just one of the Greeks and one that is most talked about: delta.

The definition of delta is the amount by which the price of an option changes for every dollar move in the underlying instrument. There are other definitions that we’ll discuss, but they all have the basic tenants. 

The above definition basically tells us that when we buy an option with a delta of 50, the option will move 50-cents for every dollar move in the stock. Another definition of delta is that is provides the odds of an option finishing in the money [ITM]. This makes sense, as an option that is at-the-money [ATM] usually has a delta near 50. This means that the ATM option has a 50 percent chance of being ITM at expiration. An out-of-the-money [OTM] option will have a delta below 50 because its odds of moving ITM are lower.

A common term heard from option traders is “delta neutral.” This term refers to a trade that the total of all deltas is close to zero. For example, a straddle is a delta neutral strategy because it normally uses two ATM options. An ATM call has a delta of 50 while an ATM put has a delta of -50. The result is a trade that is neither bullish nor bearish. The question many traders will ask is how can a trade like this become profitable?

This is a good question so let’s look at it closer. Delta has a companion Greek called gamma. Gamma is the rate of change of delta as the underlying security moves. What this tells us is that as a stock moves higher or lower, delta changes and changes at the rate provided by gamma. Therefore, a high gamma option will see larger moves as a stock rises or falls than a low gamma option. 

Since we are using buying options when trading a straddle, we have limited risk. As the underlying moves higher, the call will increase in value and the put will decrease. However, the put option can only go to zero, but the call can rise indefinitely. As a result, we have unlimited reward with limited risk and we don’t even need to pick which way the stock will move. 

The Greeks are important to understand, especially delta, so spend time to study and experiment with delta and how it impacts a trade. Over time, delta will become a well known term for you and will help your trades become more successful.

Jody Osborne
Senior Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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