The price of an option does not move up or down in the air, rather there are various factors that determine the price of the option. These factors quantify the change in price of an option and are called Greeks. They are four in number and named as Delta, Gamma, Vega and Theta. Each Greek has its own importance. In this article we will discuss about Delta.

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What is Delta?

Have a look at the following graphical presentation. There is Reliance 15minutes chart on the left and Reliance 2340 call option chart on the right. These charts show us that an upward movement in the price of an underlying (Reliance stock) leads to an increase in the call option’s price. But how is the movement in the price of an option determined? Or can we estimate the movement in option’s price in relation to the underlying?

The answer is yes. Delta is the ratio that determines the change in price of an option with respect to the underlying stock or index. We will discuss how this happens.

But let’s first discuss a bit more about the basics of Delta.

Reading Delta

The value of an option’s Delta fluctuates between 1 and -1. The deeper an option goes in to the strike price, in the money (ITM), the more the Delta moves towards 1 or -1.

Generally, the Delta of an at the money (ATM) option will be around 0.5 or -0.5. Also, the Delta for an out of the money (OTM) option will be less than 0.5 or more than -0.5 (towards zero), see in the above picture.

Let us understand with the help of live option data.

The current market price of Reliance is 2400. You can observe from the above option table of Reliance that Delta of CE increases as the option goes deep ITM. For example, the Delta of 2260 CE is more than 2400CE. Also, there would be a Delta decrease as the CE goes OTM. For example, delta of 2520 CE will be far less than 2400 CE. The same is true for PE options that is, high delta for ITM and less for OTM.

But what does a higher and lower Delta mean?

In simple words, the higher the delta the higher will be the movement of the option with respect to the underlying. For example, if Reliance stock moves up then an ITM CE (higher delta) will add more premium than an ATM CE (lesser delta) and an ATM CE will add more premium than an OTM CE (even lesser delta). Still confused? We will do it with the help of examples.

But there is another important question. How much an option will move for a one point move in the stock price?

The following examples will make it clear.

Calculating Option’s Price with Delta

Reliance is currently trading at 2400.

Let’s first take the case of CE options. I hope you know that a CE will add more premium (means its value increases) as the stock goes higher and it loses premium as the stock goes down.

OTM CE

2460CE

Price = 17

Delta = 0.3

Reliance moves up from 2400 to 2410, that is 10 points

CE moves up by 10 x 0.3 = 3pts

2460CE = 17 + 3 = Rs.20

ATM CE

Reliance 2400CE

Price = Rs.41.2

Delta = 0.55.

Reliance moves up by 10 pts

Then 2400CE will move up by 10 x 0.55 = 5.5pts

So, 2400CE value will be 41.2 + 5.5 = Rs.46.7

ITM CE

But if we have 2260CE which is deep in the money

Price = 151.65

Delta = 0.94

Reliance moves up from 2400 to 2410. Then for this 10pts move

2260CE will move by 10 x 0.94 = 9.4pts

So, 2260CE = 151.65 + 9.4 = Rs.161.05

Now let’s discuss the case of put options. But let me make it clear for new option readers that buying a PE means that we are bearish on the market. PE will add more premium as the stock goes down. Conversely, it loses premium as the stock goes up.

OTM PE

2340PE

Price = 11.95

Delta = – 0.21

Reliance goes down from CMP 2400 to 2390 = -10 pts

PE moves up by = -10 x – 0.21 = 2.1pts

2340PE price = 11.95 + 2.1 = 14.05

ATM PE

2400PE

Price = 29.9

Delta = – 0.43

Fall in Reliance = -10pts

Increase in PE = -10 x – 0.43 = 4.3

2400PE = 29.9 + 4.3 = 34.2

ITM PE

2520PE

Price = 114.45

Delta = – 0.85

Reliance moves = -10pts

PE moves = – 10 x – 0.85 = 8.5pts

2520PE = 114.45 + 8.5 = 122.95

I hope it is clear from the above examples that which option adds more premium and by how much.

So now we understand that by knowing the delta of an option we can estimate the price of that option for specific increase/decrease in price of the underlying.

I hope you enjoyed reading the article and leant something new. Next week we will discuss some simple strategies related to delta, so stay tuned.

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Thanks for reading.