Delta Gamma Theta Vega

This is not the name of an extra-geeky college fraternity. It’s a list of the greeks, a set of variables that describe how option prices change when certain things happen.

Last time, I mentioned Delta in connection with the hedging of option positions. This week, we’ll cover Delta in more detail.

Since options represent the right to buy or sell something, their value should change when the value of that something changes. The Delta of the option measures just how much, in dollars and cents, the option’s per-share price should change, for the next one-point change in the underlying asset’s price. (For stocks, one point means one dollar, but this is not true for every underlying asset. Indexes, for example, do not represent dollar values – 1400 on the S&P in no sense means $1400 – it’s just points, a mathematical calculation).

Back to option deltas. If an option has a delta of .48, that means its price should rise by 48 cents (48% of a point) when the underlying rises by a full point; and it should fall by 48 cents when the underlying falls by a point. All else being equal, call options must become more valuable as the underlying rises, as the right to buy the underlying at a fixed price provides more and more of a discount compared to the current price. Since calls have to move in the same direction as the underlying, their deltas are positive numbers. By the same logic, the deltas of puts are negative numbers – their values go down when the underlying rises. A put with a delta of -.48 would drop by 48 cents (or you could say that it would rise by minus 48 cents) if the underlying rose by a point.

Delta always has to be a fraction. It can… Continue Reading