For example, the Honeywell September “at the money” strike of 157.5 closed on August 24 at 2.56 (midpoint of the range). The stock is trading at 157.51. The current delta is .51. So, theoretically if the stock moves up one dollar, this option will jump up 51 cents to 3.07. That is an astonishing 20% move in options price (from 2.56 to 3.07) vs the stock price gain of less than 1%.
The option price is also affected by other Greeks like theta and gamma; both tug at the option price as the stock price stalls or moves slowly. For all intents and purposes, the delta will help you figure out the potential gain you can expect by options trading as it relates to a move in the stock price.Understanding this provides you, the options trader, with some great leverage.
How to use delta to understand your odds
I look at delta as a probability tool. What are the odds the stock will finish at a strike by expiration? I like to know if a play is low or high probability and if I’m going to be paid based on the risk I’m willing to take. If I’m comfortable taking a low probability play, then that is my reference point.
Some option players like low-probability, high-risk trades. Delta helps you determine these probabilities.
It’s very simple to assess the odds. Taking the above example. Honeywell has a 51% chance to stay in the money. It is currently right there, so why wouldn’t it be 100%? We have to factor in the time consideration and the potential for the stock to move lower. If Honeywell had zero implied volatility (aka, no volatility is expected) the delta would be 1. That is never the case, though.
Instead, I look at the implied odds of a 50% move up and the price of the option, and then I assess my risk. Is this in my wheelhouse for risk-taking? Without considering the chart/technicals, I can determine my risk based on the delta of the option.
If you’d like to begin using delta as part of your options trading tool kit, this is a great place to start.
Delta symbols courtesy of Quora.