Delta, a best helper in strike selection
Options Delta is a measure that tells us how much an Option premium would move if the underlying moves by Rs 1.
F&O
We all must agree that one crucial element in making money in Options trading is the right strike selection.
Example: Stock @ 100. Buy 110 Call @ Rs 0.30. Stock @ 102
110 Call @ Rs 0.6 = 100% returns but profits are almost nil after transaction costs.
Instead, Buy 102.5 Call @1.7
@110, 102.5 Call = 2.6 = Rs 1+ profit, decent returns of 60%.
Thus, strike selection is equally important as we are trading and Deltas help in such strike selection.
Let’s understand Delta and draw down the guidelines for identifying efficient strikes to Buy & Sell.
What is Delta?
Options Delta tells us how much an Option premium would move if the underlying moves by Rs 1. It is the measure of sensitivity of the Options to the underlying. It is also looked at as an approximate probability of Option expiring in profit on the day of expiry.
Delta is one of the Options Greeks available on almost all Options Analytics platforms nowadays.
Call option Deltas are positive because of the positive relation between Call options. The Underlying Rs 1 rise will lead to a rise in Call premium and a fall would lead to a fall in premium.
Similarly, Put Option Deltas are negative. Because Puts will rise with a fall in underlying and a fall with a rise in the underlying.
Thus, Call Deltas range between 0 to 1 and Put’s between 0 to -1. 0 being no sensitivity and 1 being most sensitive, Option moving INR 1 with INR 1 move in the underlying.
While choosing strikes for buying or selling Call or Put option we will look at the absolute number and not the sign. So, 0.25 Delta for Call is similarly effective as -0.25 Delta for Put option. Lastly, the smaller the Delta (ignoring the sign) cheaper will be the premium.
How do we use it while Buying Options?
While Buying anything we want to buy cheaper. But we saw what happened to the 110 Call premium when the stock moved. So, beyond how cheap we can not go lower in paying premium becomes a question.
Delta has the answer. 0.4 Delta is one of the sweetest spots to buy Options. In our example, 102.5 was 0.38 Delta. We see the effectiveness. A lot higher premium will reduce the returns on our premium investments and as we saw cheaper is not the best way to go either.
How do we use it while Selling Options?
Here, we need to sell Options with the least probability to expire in profit on expiry. Remember, Delta is also looked at as a probability of Options expiring in profit on expiry (for the buyer).
So, a seller looking to Sell with a reasonably lower probability of loss could sell the 0.25 Delta Option.
The amazing thing about this is if the stock is too volatile this 0.25 delta Option strike would be away from the current market price. For a least volatile stock, it could be closer. Delta does the safeguarding against volatility for us.
First published on 29 Jul 2023: prices, lot sizes and expiries are those of that time. They are illustrations for education only, not investment advice. Derivatives trading carries risk; read all scheme and risk documents before trading.
