Thursday Q&A

Thursday Q&A Hello Smart Option Sellers! Here's your next installment of the Q&A alert. Enjoy! Q: good morning lee is delta a good indicator of probability A: For those of you unfamiliar, Delta is a by-product of the option pricing formula and is known as one of the "Greek" outputs of the model. It is represented by a percentage number between 0% - 100%. Delta has a few uses, or meanings: 1. Delta tells you how much an option price will move in relationship to the underlying security's move. For instance, if the option (put or call) has a delta of 60%, its price should move 60% of what the underlying security moves. If the stock is at $50 per share, and it moves up to $51 per share, a call option with a value of $.50 per contract should move up to $.80 per contract, which is a move of 60%. This is the best definition and practical use of delta, in my opinion. 2. Delta tells you how many contracts you need to buy or sell of an underlying security to hedge your option position. For instance, when I traded crude oil options on the NYMEX, I would engage in an option position that would give me a directional stake in the underlying crude oil futures market. Since we were not in the game to predict the direction of crude oil futures, we needed to directionally offset any option position we took with an appropriate futures contract position. If I bought crude oil call option contracts, if would temporarily give me a bullish stake in oil, which I would immediately have to offset by selling crude oil futures contracts. But how many should I sell? Well, the call option's delta told me how many I needed. This definition of delta is only used by professional traders and hedgers, and in my experience, is not part of any individual retail investor's trading activities. 3. The last use of Delta comes down to your quest