Delta is a theoretical estimate of how much an option's premium may change given a $1 move in the underlying. For an option with a Delta of .50, an investor can expect about a $.50 move in that option's premium given a $1 move, up or down, in the underlying. For purchased options owned by an investor, Delta is between 0 and 1.00 for calls and 0 and -1.00 for puts. For sold options, as the investor essentially has a negative quantity of contracts, we find that short puts have a positive Delta (technically a negative Delta multiplied by a negative number of contracts); short calls have a negative Delta (technically a positive Delta multiplied by a negative number of contracts).
For example, the XYZ 20 call has a .50 Delta and is trading at $2 with XYZ stock at $20.50. XYZ rises to $21.50. The investor would expect that the 20 strike call would now be worth around $2.50 as seen below:
With a $1 move down in XYZ, the investor would expect to see this same 20 strike call option decrease in value to around $1.50. As the stock price rises and the call option goes deeper-in-the-money, Delta typically approaches 1.00 because of the increased likelihood the option will be in-the-money at expiration. As expiration approaches, in-the-money-option Deltas are also more likely to be moving slowly toward 1 because at expiration an option either has a Delta of 0 or 1.00 with no time premium remaining.
- $1 increase in underlying price x .50 Delta = $.50 anticipated change in option premium.
- Original Premium: $2.00 +$.50 estimated change = $2.50 estimated new premium after $1 stock price increase.
The picture below shows how you can incorporate Delta into your analysis: