What Is Options Delta

What Is Options Delta

Options delta is one of the most important concepts for options traders to understand. In a nutshell, delta measures how much an option’s price will change given a $1 move in the underlying security. But there’s more to it than that, so let’s take a closer look at this important measure. 

In addition to explaining delta, we’ll also discuss some of the factors that can affect an option’s delta value. By understanding these factors, you’ll be able to make better trading decisions and increase your profits. So let’s get started!

Key Takeaways

• Delta is a measure of the price difference between an option’s current market value and its intrinsic value
• Intrinsic value is the portion of an option’s premium that is based on the underlying security’s current market price
• Time value is the remaining portion of an option’s premium, which reflects the time remaining until expiration and volatility
• Option traders use delta to gauge how sensitive a particular option contract is to changes in the underlying security’s price
• Delta can be positive, negative, or zero, depending on whether the option position profits from a rise (positive delta), falls (negative delta), or remains unchanged (zero delta) in the underlying security’s price

What Is Delta

Delta is a number used to calculate the participation rate of an options contract. What does that even mean? It means that delta dictates how much an options contract will change for every $1 the underlying asset moves in price. Why is this important? Traders need to understand how delta affects an options contract because it will determine how profitable the trade is and how likely the trade is to be profitable. Doesn’t that seem like it would be an important thing to know?

Understanding delta

Let’s consider a quick example of how delta affects an options contract:

A trader purchases a call option contract on Tesla (TSLA) for $500. This call option contract controls the movement of 100 underlying shares. If the Tesla share price moves up in value $10, the option contract should increase in value by $1,000. But it doesn’t. Why? Because of the delta. 

Delta is known as the participation rate. What does that even mean? It means that if the value of delta is .5, the options contracts value will increase by .50 cents for every $1 Tesla moves up. So if the long call option contract has a delta of .5, the options contract value would have only increased $500. ($10 price increase x 100 shares x .5 delta =500)

Delta can have a positive or negative value. For example, if a trader buys a put contract on Tesla with a -.5 delta, the options contract will decrease .50 cents for every dollar the option contract increases in value. This is because a put options contract is a “wager” that the underlying asset will decrease in price. 

How do options traders use delta?

Options traders use delta to make informed decisions about the options contracts they buy or sell. Delta tells options traders how much the options contract value will change and how likely an options contract will be in-the-money (ITM) at expiration. What does that mean? Traders use this calculation to determine the probability that a trade will be successful and what the potential profit will be. 

On the trading platform thinkorswim, delta is located under the options chain menu. 

If you are interested in learning the more advanced features of thinkorswim, check out our advanced tutorial library in the Traders Education Center.

Cheaper is better, right?

Wrong. As John Carter always says, buying cheap, out-of-the-money (OTM) options is a rookie mistake. When traders buy cheap out-of-the-money options, they buy 100% premium, meaning the options have no actual value. OTM options have a low delta. What does this mean? It means that the probability of the OTM contract being profitable at expiration is low and that the underlying stock must have to have a larger-than-expected move just to break even. Buying options with a low delta is usually a mistake because of its low probability. 

What is the best options delta?

What is a good delta for options? The whole point of buying an options contract is usually to make a profit. If you want to increase the odds of your options contract being profitable at expiration, you have to buy deeper in-the-money contracts. We prefer to buy options contracts with a delta of .70. These options are more expensive than the cheaper out-of-the-money contracts but are much more likely to be profitable. They are also more sensitive to the price movement of the underlying asset. With a delta of .70, an options contract value will increase by .70 cents for every dollar that that the underlying asset moves. We have found this to be the “sweet spot” where the contracts are not too expensive and they have a higher probability of being profitable. 

In conclusion 

Options trading can be tricky. Understanding how delta affects every contract you buy will help you to make better decisions when selecting contracts. Did you know that in addition to delta, there are 3 other greek measurements that affect the price of options contracts? We cover the greeks and many other options trading concepts in our free trading room. If you’re interested in learning more, check out our free training room.

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