“The option would be a contract that gives the client the correct, but not the need, to buy or sell an underlying asset at a specific value on or before a certain date”.
Here a buyer can purchase an option (say to buy an asset) from the holder of the underlying asset (seller) by paying a fraction of the total investment amount up front. The buyer then has the right to exercise his option but not the obligation to do so.
If the buyer decides not to work out the option, he will be at a loss of 100% amount used to pay for the options upfront.
An investor involved in options trading has the support of four risk measuring tools to assess the level of responsiveness and potential exposure of options as a result of changes in variables such as time factor, market volatility, change in the price of the underlying asset etc.
A systematic stock research is necessary to comprehend the effect of these variables on options in order to make an informed decision on investment in options.
Delta is one among the four risk measuring tools along with Gamma, Theta, and Vega that assist in the technical analysis of the options.
Delta formula for call option :
δ=N(d1)
where d1=(ln(S/K)+(r+σ22))/σ√t
Here
K - Option strike price
N - Standard normal cumulative distribution function
r - Risk free interest rate
σ - Volatility of the underlying
S - Price of the underlying
t - Time to option's expiry
Delta formula for put options :
δ=N(d1) −1
where d1= (ln(S/K)+(r+σ22))/σ√ t
Here
K - Option strike price
N - Standard normal cumulative distribution function
r - Risk free interest rate
σ - Volatility of the underlying
S - Price of the underlying
t Time to option's expiry
Delta acts as a tool to trade options :
Delta is a measure of the relative level of exposure of option to changes in the price of the underlying asset.
Delta is a theoretical approximation of the change in the return from an option for every unit change in the value of the underlying asset.
Delta values range from 1 to -1 based on whether the option is to call or put and out of the money or at the money.
Principal use of Delta :
The principal use of Delta is to assist investors in online trading to find out the probable oscillation in options value as a effect of change in the price of underlying asset which assiststo project the money that one could make or lose by buying/exercising a particular option.
Delta on the other hand, can be used to mark a cut off target for your trades and realize the profits or restrict the losses from the options.
Delta is not stable and keeps varying with alterations in the market.
Delta is more often than not higher for options nearing expiration period and a stable check on Delta movements can assist options traders establish the plan of action and make the most of profits.