When using delta in call options trading, the delta value helps you understand how much the price of the call option is expected to change in response to changes in the underlying stock price. Here’s how you can use delta in call options trading:
- Understand Delta Range: Delta values for call options typically range from 0 to 1, with 0 representing an option that is far out-of-the-money (OTM) and 1 representing an option that is deep in-the-money (ITM). The closer the delta is to 1, the more the option’s price will move in line with the underlying stock.
- Assess Delta Sensitivity: Higher delta values indicate a stronger correlation between the call option’s price and the underlying stock’s price. For example, if the delta of a call option is 0.7, it means that for every $1 increase in the stock price, the call option’s price is expected to increase by $0.70. This sensitivity helps you evaluate the potential profitability of your call option strategy.
- Determine the Right Delta: Choose a delta value that aligns with your trading objectives and risk tolerance. If you have a bullish outlook on the stock and want to closely track its movements, you may consider buying call options with higher delta values (e.g., 0.7 or above) for a stronger correlation to stock price changes. Lower delta options (e.g., 0.3 or below) may be suitable for less aggressive strategies or when you anticipate smaller price movements.
- Evaluate Time Sensitivity: Keep in mind that delta values are not static and change with time. As expiration approaches, the delta of an option can change significantly. At-the-money (ATM) options tend to have delta values around 0.5 initially, but as expiration nears, the delta will move towards 1 for ITM options and towards 0 for OTM options. This change in delta over time is known as the “delta decay” or “time decay.”
- Monitor Delta Changes: Regularly monitor the delta of your call options position as the underlying stock price fluctuates. If the stock price increases and the call option’s delta moves closer to 1, the option’s value will rise more rapidly. Conversely, if the stock price decreases, the delta will move away from 1, causing the option’s value to increase at a slower pace. Paying attention to delta changes helps you assess the effectiveness of your options strategy and make informed decisions.
To determine which delta to use, let’s take a stock trading at $20 with a one-year price target of $30. If you have a bullish outlook and believe the stock has a high probability of reaching the $30 price target within one year, you might consider using a higher delta value. A delta of 0.7 or above would imply a strong correlation between the call option’s price and the stock’s price. In this case, a call option with a higher delta would capture a significant portion of the stock’s potential price increase.
On the other hand, if you are more conservative or uncertain about the stock’s price movement, you might opt for a lower delta value. A delta of 0.3 or below would indicate a weaker correlation between the call option’s price and the stock’s price. Lower delta options may be more suitable if you anticipate smaller price movements or want to reduce the impact of short-term volatility.
Remember that delta is just one factor to consider when trading call options. It’s important to conduct comprehensive research, analyze other options Greeks (such as gamma, theta, and vega), and understand the risks involved in options trading. Consider consulting with a financial advisor or investment professional who can provide guidance tailored to your specific trading goals and risk tolerance.