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Delta is the amount by which an option price is expected to change if there is a one point change in the price of the underlying asset. Long call options have positive deltas, and long put options have negative deltas. From a mathematical standpoint, deltas change for any fractional change of price in the underlying asset. However, when working with deltas, the delta measurement is generally stated as the effect on the option price relative to a full one point change in the underlying asset price.
The value of delta ranges from -1 to +1. This means that the maximum delta for a call option is +1, and for a put option is -1. The more in-the-money a call option is, the closer to 1 the delta becomes. The more in-the-money a put option becomes, the closer to -1 the delta becomes. The more out-of-the-money an option is, the closer to 0 the delta becomes. A good rule of thumb is that when an option's delta is about 0.5 for a call, and -0.5 for a put, the option's strike price is at or near the price of the underlying asset (at-the-money).
An option's delta is often used as an indicator of its likelihood to expire in-the-money. This interpretation of delta, while not correct according to option pricing model theory, can be helpful. Accordingly, an option with a delta of 0.40 would have a 40% chance of expiring in-the-money, while an option delta of 0.80 can be said to have an 80% chance of expiring in-the-money.
Following is an example of how delta works:
XYZ common stock is trading @ 37.
Long XYZ May 40 Call @ 1.00 (the price of the option) has a delta of .375.
If, XYZ common stock rises in price 1 point to 38
Then, Long XYZ May 40 Call is expected to increase in price to 1.375
The delta for a single option can give a trader or investor a good indication of how the overall value of a position may increase or decrease. This is particularly helpful for short-term moves in the underlying asset. Having the ability to monitor and realistically judge the option price movement as it relates to the underlying asset can give an options trader an edge.
A common strategy that uses delta to hedge positions, particularly a position in the underlying asset, is referred to as a hedge ratio. A hedge ratio strategy utilizes options to offset a position in the underlying asset by calculating deltas to maintain an overall delta position of near zero. For an example of how you might use a hedge ratio, see About a Hedge Ratio.
Each of the four basic legs used to create positions and strategies has a delta value, either positive or negative. The delta of an underlying asset itself is considered to be 1 for each unit of the underlying asset, a +1 for a long position, and a -1 for a short position.
