trading strategies

Introducing: Delta

Options are complex!  Their value being determined by a long mathematical equation, with many sub-equations and variables.  I can’t write the formulas out for you.  Not because they’re secret, but because my keypad doesn’t contain the crazy looking symbols used in the formulas.

Each aspect of option pricing is a separate component of the formula. To remove confusion, each component has a Greek title; Delta, Gamma, Theta, Vega, and Rho.  Do you wonder? Should that last sentence read, “To ADD confusion?”  Everyone knows Vega is not Greek.  It’s a Chevrolet.

The first and most important of the “Greeks” is Delta.  It is probably one of the most common known of the “Greeks,” but it can be looked at three ways.  Two of which are widely accepted.  The third is far less important and really only theoretical.  Most quasi-knowledgeable traders only know one or two.

Have you signed up for my free report? Use the form on the right.

The first and most important way to look at Delta:  Delta measures the rate of change in an option’s price compared to a one point ($1) movement in the underlying security.

Since the rate of change in the price of a stock is measured dollar for dollar, their movement is 100%.  Stocks have a Delta of 1.00.  Don’t worry; stock prices do not have any other “Greeks,” only Delta.

Option prices, which don’t move the same dollar for dollar as stock prices, have lower Deltas.  Think of it as a percentage of the movement of the stock price.  If a stock goes up $1 and an option on that stock went up 1/2, it had a Delta of .50.

Many times Deltas are not mentioned with decimals but as whole numbers.  Since options trade 100 shares of stock per contract, the decimals are dropped.  Example:  .50 x 100 = 50.

Deltas can never be over 1.00 (one hundred).  If you ever see an option move greater than the underlying, it was caused by another of the “Greeks.”  In our examples, we will assume everything else remains constant.  In reality, the other “Greek” forces are at work, but for explanation sake, they will remain silent.

The at the money (ATM) Call will typically have a delta of .50.  In the money (ITM) will have a higher delta.  The Delta is still higher on deep in the money (DITM).  The opposite is true for out of the money (OTM) and deep out of the money (DOTM) options, their Deltas are lower.

An understanding of Delta helps option traders choose strike prices.  To be profitable with small price movements, you will need to buy ATM or maybe even ITM options.  The difference between the Bid/Ask spread may be too great to overcome with OTM options.

The parameters of our hypothetical example:  $30 stock, $25 Call price $6 Delta .75, $30 Call price $2 Delta .50, $35 Call price $1 Delta .25.  If the stock price increases $1 to $31, the $25 Call would increase .75 to $6.75.  The $30 Call would rise to $2.50, the $35 Call would increase to $1.25.

Let’s say the Bid/Ask spread on the $35 Call was .75/1.00 when the stock was $30.  After the $1 price rise in the stock the Bid/Ask spread might have become 1.00/1.25.  If you buy @ $1 and can only sell @ $1, you lose the cost of commissions.

Delta is dynamic.  When the stock price moves, the Delta changes.  Delta will increase as the stock price increases.  Delta will decrease if the stock price falls.  This change is known as Gamma.  Think of Delta as speed and Gamma as acceleration.  We will go into Gamma later in much greater detail.

Delta also changes as time passes.  As option expiration gets closer the Delta for the ITM option increases towards 1.00, and the Delta for the OTM option decreases towards .00, while the ATM option’s Delta will almost hold at .50, right until expiration.

OTM options are usually a bad deal.  There’s generally not enough time for the price to rise and the Delta is too low, the exception is with Leaps.  The Deltas on Leaps will be closer to .50.  ITM Leaps will have lower Deltas than short term options.  OTM Leaps will have higher Deltas than short term options.  Most people are unaware of this phenomenon.  It can be used to great advantage in calendar spreads.

Every option trader should know Delta!  Its okay not to know Rho, but knowledge of Delta is essential.  You will need to understand Delta before trying to grasp Gamma (my favorite).

In order to understand option strategies, especially using weekly options it is necessary to understand Delta – hopefully you do now.  As always if you have any comments please leave them below.

Lets begin this post with a discussion about hardware.  I will get to trading strategies and trade ideas in a little while.  You need some hardware before you can run some software (which I will also discuss) in order to analyze what the markets are doing.

Any system that will run the current Windows 7 has enough horsepower to run all the current trading platforms.  My recommendation is to get as much memory as you can afford or can fit into your computer.  And then to get the 64 bit version of Windows 7 –  this will give you a machine that will be a little ahead of the curve and last longer then a machine with a 32 bit operating system.  Next to consider is your choice of monitors.  Do you go with a single large monitor or two smaller ones?  Both will work fine – it will depend on your budget and space on your desk.  I prefer 2 larger monitors – I use 2 – 24 inch currently.  A single 30 inch would work very nice as well.    My monitors are a bit older and not in the new widescreen format.  Widescreen means that the width to height of the monitor is in the relationship of 16:9 which is great for watching movies on your computer.  But I do not like them for looking at charts or working on my computer.  The problem is they are very hard to find and I have been told that the major manufacturers no longer make them.  Just the widescreen models 🙁

Have you signed up for my free report? Use the form on the right.

Now for software – I have tested Think or Swim, Tradestation, eSignal platforms and find them all to be great.   So the important thing to see is what you are comfortable using.  And also the costs involved.  Some platforms will be free (except for exchange costs) like Tradestation, and some you will need to add a data service on top of the platform.  A lot will depend on your brokerage and the platform they use and the costs involved.  I like Think or Swim and love Tradestation which is my platform of choice.  Look around and try what is out there and find a platform that works best for you.

 

Welcome to My Blog!

Well I admit that I am new to this, so bear with me while I figure things out and put up something that all of you will find interesting to read.

A little about me first – why not it IS my Blog….  I have been trading actively for about 35 years.  Everything from T-Bonds, T-Bills, stocks, options, futures – pretty much everything possible except for Forex.  I simply feel that the futures are a better deal to trade then Forex.  If you think differently – be my guest and leave a comment below.

Have you signed up for my free report? Use the form on the right.

Currently I am focused on trading Weekly Options as you might have guessed by the name of this Blog.  Weekly Options are set by the CBOE – Chicago Board Options Exchange, and right now they are a work in progress.  This means that new ones are still being added and also others are being removed.  To check the current list of weekly options please visit:  http://www.cboe.com/TradTool/Symbols/SymbolWeeklys.aspx.

This blog will not be a primer on option trading – but we will define the terms that we will use – for example option greeks, and how to use them in trading option strategies.

This blog will discuss current market conditions, weekly options, use of weekly options for trading, trading strategies for weekly options, my trading and anything else that I and you the reader might find interesting.

Leave a comment below if you have a topic that interests you.

 

For my free report:

LeadsLeap