Know your Delta (part 2)
So to continue from part one where I said: Delta is a measure on how the price of an option may vary in relation to the change in the price of a stock. Delta can vary between 1.0 and -1.0 (sometimes expressed as 100% or -100%).
Delta is a theoretical value and for some people it may complex to calculate. It is based on a theoretical value. And worse, delta cannot be found on most tables available on the internet.
However the simple way to look at Delta is as follows:
For a CALL option, the strike level (exercise price) can be above the underlying (out of the money) it can be close to the underlying stock price (at the money) or it can be below the underlying price (in the money). For a PUT option, the strike level (exercise price) can be above the underlying (in the money) it can be close to the underlying stock price (at the money) or it can be below the underlying price (out of the money).
Delta is stated as a percentage (or a decimal figure). If an option has a 50 (or 0.5), delta is at the money and close to the underlying stock price, and its price will change by 50 percent of the change of the underlying stock price. So if an option has a 50 percent delta, this will be indicated as 0.50, or 50. CALL option values increase when the underlying stock price increases and vice versa. Because calls have this positive correlation with the underlying, they have positive deltas. Puts have a negative correlation to the underlying. That is, put values decrease when the stock price rises and vice versa. Puts, therefore, have negative deltas.
Look at the following example (CBA, price $78.49 – May 2014):
The option is out-of-money. The Strike price is 80.09 and therefore above the underlying stock price. We call this strike out of the money. Delta is less than 0.5. In this case, 0.272
If the price was below 78.49, we call that strike in the money and Delta will be higher than 50% (or 0.5).
The further away from the underlying price, the higher delta will be.
More tomorrow in Part 3