In this article, we will discuss
What is Delta?
Option delta is a crucial metric that measures how the price of an option changes relative to changes in the price of the underlying asset. It helps traders predict how an option's value will respond to every 1 Rupee fluctuation in the underlying's value.
Delta ranges from -1 to 1, with higher values on either side indicating a stronger correlation between the option and the underlying asset.
Interpreting Delta
Call Options and Delta
Delta for call options ranges from 0 to 1. A delta of 0 means the option's value won't change with the underlying's price, while a delta of 1 implies the option's value will mirror the underlying's price movement. Delta of ATM call options is generally closer to 0.5 and it moves towards 1 as we move to ITM strikes, and closer to 0 when we move to OTM strikes.
Delta of Call option is positive since it is positively correlated to the change in the underlying, meaning the price of call will increase if there is a positive change in underlying. For instance, if the underlying asset goes up by 1 Rupee and you hold a call option with a delta of 0.6, your option's value should increase by around 0.60 Rupee.
Put Options and Delta
Delta for put options ranges from -1 to 0. A delta of -1 means the option's value moves inversely to the underlying's price. Delta of ATM put options is generally closer to -0.5 and it moves towards -1 as we move to ITM strikes, and closer to 0 when we move to OTM strikes.
Delta of Put option is negative since it is negatively correlated to the change in the underlying, meaning the price of put will increase if there is a negative change in underlying. A delta of -0.6 signifies that if the underlying rises by Rupee 1, the put option's value could decrease by Rupees 0.60.
Delta and probability
Another interesting interpretation of Delta is to gauge the probability of the option being ITM on the date of expiry. Meaning, if the Call Delta is 0.60, there is a 0.60 probability of the option closing ITM on expiry day. So Delta can actually be used to estimate the moneyness probability of an option.
How can Delta help you become a options trader
For Option Buyers
Call option buyers may find strikes with a Delta closer to 1 more favorable due to their higher likelihood of expiring In The Money (ITM). Furthermore, if the underlying asset increases, strikes with a Delta closer to 1 will experience the gains for the same underlying movement. Similarly, for put option buyers, strikes with a Delta closer to -1 are preferable as they have a higher chance of expiring ITM.
For Option Sellers
Since the intention of the option seller is to cash in the premium paid by the buyer, it makes sense to view delta from the angle of probability of the strike being ITM. Thus for the option seller, if we were to choose an option to sell with ‘lowest risk’ or the lowest probability of it expiring ITM, then it is in the best interest of the option seller to sell call options having lower Delta - i.e. OTM options.
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