Option Greeks

Delta of an option definition
Much more is said about the interdependence of these factors later, but first let's define some terms that are common among option traders. These terms describe just how much of an effect each factor has on the stock price.

The best known such term is the delta of an option.

The delta of an option measures how much the option changes in price when the underlying moves one point.

The delta of a call option is a number that ranges between 0.00 and 1.00.

Put delta = Call delta – 1

The payoff of a put option at expiration
To verify this for yourself, note that if a call is way out-of-the-money, it will not move at all, even if the stock rises by one point.

Thus, the delta of a very deeply out-of-the-money call is 0.00. On the other hand, if the stock is trading far in excess of the striking price—that is, the option is way in-the-money—then the option and the stock move in concert.

Thus, if the stock rises by one point, so will the option; hence, the delta of such a deeply in-the-money option is 1.00.

The delta of a put ranges between 0.00 and -1.00, reflecting the fact that the put moves in the opposite direction from the underlying security. In between these two extremes (deeply out-of-the-money and deeply in-the-money), the delta of a call option ranges between zero and one.

Call options that are out-of-the-money have small deltas, such as 0.25 or 0.30, meaning that they will increase by only about ¼ or 3/8 of a point when the underlying stock rises by a point. In a similar manner, call options that are somewhat in-the-money will have higher deltas, such as 0.70 or 0.80, indicating that they will move much more like the common stock, but not quite as fast as the stock moves.

Understanding the concept of delta is mandatory for option traders, for it helps them to envision just how the option is going to move when the stock price moves.

Since most traders have a feeling for what they expect of a stock when they buy it, or even when they buy the options, the understanding of delta can help them decide which option to buy.

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