Here's Why Delta Is A Big Deal...
I often get asked why delta is such a big deal when trading options.
For those that don't know, delta is one of the Greek by-products of the option pricing model.
Over your head?
No worries. Let's break it down because delta really is a big deal and it can greatly improve your trading results if you know how to use it properly.
You see, options are an investment, just like stocks.
But with options, you can't just trade them in a vacuum and expect results.
The reason? Because an option's value is completely derived from other sources - it's the reason why it's called a "derivative" product.
And in order to understand an option's worth and how it will move, you first need to get a grip on its underlying security.
The underlying security is the stock (or commodity or bond) on which the option is based.
So, if you're going to trade Microsoft (MSFT) options, then you need to have an opinion about MSFT stock first. There's no sense in trading MSFT options if you have no thoughts on the stock.
All option prices on MSFT are tied to the movements of MSFT stock, so it's best to know what your directional assessment is. MSFT options are derived from where MSFT stock trades. That's how it works.
Now, an option's value will fluctuate higher or lower depending on how the stock moves.
And once the stock starts to move, how much do you think the option should move?
Have you ever thought about that concept?
I know some novice traders think that the option will "just move" because the stock does.
Really? Don't be so sure.
Yes, in most cases, the option price will move, but do you know by how much?
Here's the secret:
Delta tells you how much the option price will move in conjunction with the stock's movement.
That's a very important concept, and not all deltas are created equal.
Deltas range from 0-100 (0% to 100%), and each individual option has its own delta.
So if an option has a delta of 50 (50%), then it's price will move roughly half of whatever the stock moves.
Why is that important?
Well, don't you want to buy an option that's going to move when the stock does?
It would seem like a "duh!" question, but most beginner option traders have no clue about it.
Let me show you something.
Above is an option chain for Microsoft using the June 19, 2020 expiration.
With MSFT stock at $167.10, I've circled two different call options with two very different option prices and deltas.
If you're bullish on MSFT, I bet at first glance, you'd probably choose the $185 call options because their price is much cheaper compared to the $145 call options.
I mean, who wouldn't want to spend $2.51 per contract (splitting the bid/ask) instead of $24.80 per contract (splitting the bid/ask).
In real dollars using the 100 share multiplier, that's $251 versus $2,480.
Of course most people would choose the $185 call because they're so much cheaper. It's a savings of roughly 90%.
But, is that really the best choice?
The deltas are vastly different: 22.61% versus 82.79%.
For every $1 move in MSFT, the $145 call options will move 82.79% of it and the $145 call will only move $22.61% of it.
Break-evens and Odds
Now, two of the other biggest factors that affect your potential profitability are how long you hold onto the option and how similar the option's breakeven price is to the stock's breakeven price.