The Best Way to Evaluate Option Delta
10/25/2011 8:00 am EST
Learn how floor traders think about Delta, the primary option Greek, and begin applying this method of thinking for greater success in your own option trading.
It was standard trader lingo on the trading floor: “What’s your Delta of making it to the party tonight?” “What’s the Delta the broker comes back and buys more of these?” “I’m about 90 Delta I’m going to dump Sheila tonight.”
I probably used the word “Delta” in this context every single day of my life when I hung out with mostly all traders; as did, well, mostly everyone I hung out with.
It’s the “traders’ definition” of Delta—that is, the likelihood of an option expiring in the money. Though this definition actually has a few mathematical shortcomings, making it not entirely technically correct, every professional option trader I know thinks about Delta this way. And, in turn, most traders borrow the concept of Delta being the likelihood of success to adopt into their everyday speech.
The idea is that every option has an associated Delta figure attached to it. Like, at the time of this writing, the Exxon Mobil (XOM) November 82.5 calls have a 0.25 Delta. Yes, that means that they change in value 25% like the underlying stock. But it also is interpreted by traders to mean that the XOM November 82.5 calls have a 25% chance of expiring in the money.
This practical use of Delta helps guide traders’ expectations and helps them make better trading decisions by factoring probability into their decision-making process. I encourage traders to think about option Delta this way. You should start today; I’m 100 Delta that you’ll be glad you did!
See related: How Delta Affects Option Profits
By Dan Passarelli of Market Taker Mentoring