Only the delta is important to us
In Options Trading, the 5 Greeks are: Gamma, Delta, Theta, Rho, and Vega. They are described below but at our level of trading it is only the Delta that we need to know about. The rest can best be left for the professionals.

The trader does not really need to know anything about the academic theory of options pricing or the background leading to the development of a mathematical model that calculates price changes and their relationship to a number of trading variables, a model known as the Black-Scholes model. Suffice it to say that you know it exists. Just for the record, the Greeks are listed here. Don’t bother to remember them, you can look them up if necessary but I don’t know why there would be any need to, at least in the early days of trading options.

Factors in the Black-Scholes equation are referred to individually by letters of the Greek alphabet, namely:

Gamma – is a measure of delta’s sensitivity to changes in the price of the underlying asset.
Delta - is a measure of an option’s sensitivity to changes in the price of the underlying asset.
Theta – is a measure of an option’s sensitivity to time decay.
Rho – is a measure of an option’s sensitivity to changes in the risk free interest rate.

And a fifth factor is named Vega, not really a letter of the Greek alphabet but most people assume that it is — but it really doesn’t matter anyway.

Vega – is a measure of an option’s sensitivity to changes in the volatility of the underlying asset.

Delta, always difficult to explain

Delta is the numerical quantity, a decimal number between 0 and 1, assigned to the value of an option in relation to the price of its underlying stock.

As a stock rises or falls in price, its delta value of the option will change accordingly. For practical purposes, when expressed in a chart of available options for a specific stock, the delta indicates how much the option can continue to gain in price for every $1 that the underlying stock gains in price from that point.

My own “interpretation”:

For an easier way for me to understand it is to ignore the decimal point and when I see a delta value such as .63, I read that as 63 (sixty-three). That 63 in the case of an option that has a delta value .63 tells me that the option will increase in value by 63 cents when the price of the underlying stock increases by $1.

Example: If an option’s delta is .63 when the underlying stock is at a specific price, the value of the option will increase by 63 cents if the stock rises in price by $1. If the delta is .55, the option will increase by 55 cents when the underlying stock goes up by $1.

And so on, the delta tells you how much the option will increase with every $1 increase in the underlying stock and from that point each change in stock price will have a different delta value than that of the stock’s previous price, higher when the stock goes up, lower when the stock goes down.

To state it a little differently, as the price of the underlying stock continues to increase by each $1 amount, the delta value will also change and increase gradually in unison with the $1 price increases in the stock, from. 63 to .64, .65, .66, on up to a possible 1.0 at which time it reaches its maximum, meaning at that point for however many $1 increases occur in the value of the stock, the increase in the option delta stays at 1.

The delta is not a fixed percentage of the stock’s price and the values are derived from a formula that takes into account several factors, including the price of the stock and the time left until expiry of the option. As the call option gets closer to its expiry date, its delta approaches closer to 1.

It is difficult to explain or to comprehend from an explanation, it is easier to understand how it is used and I will just say that experience taught me to:

1. Select an option with a delta value in the low 60’s if one is available.

2. As the price of a stock rises, the delta of a call option will also rise towards the maximum of 100, if it reaches that level or even to the 90’s it is time to sell the option or roll up to a higher priced option. The term ” roll up” is explained below.

Those are my own methods that I found useful and to be guidelines of value, I don’t recall seeing them written anywhere, it is possible that other traders use the delta values differently.

Rolling Up
To Roll up means to exit the current position while simultaneously taking a new position in an option with a higher strike price in the same underlying stock. That would be done if it is believed that the stock will continue to go up in price. And the position would be closed when the option has a delta in the high nineties because the range of possible profit is less than it would be with a lower delta – such as in the 60’s.

There may be other factors to take into account when making such decisions, including the market action in general, the pattern of the stock’s action, volatility of both, or other related aspects that differ and affect various trades.

Management of risk in trading options and minimizing the risks attached to all trading activities is paramount and should be a guiding principle.

Related posts:

  1. Buy the Stock or Buy the Option? Risks and Rewards in Trading Options
  2. Trading Options with an added “twist” to the basic strategy
  3. Rolling an Option to Maintain a Position
  4. The Stock Chart and a Simulated Trade to Buy Shares and Options of AGCO
  5. A Case for Buying Options Instead of Buying Stocks
  6. Trading Options for the Beginner
  7. Trading the NASDAQ Index with ETFs and Options as an Alternative to Buying Shares

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