Papale on Delta

A guy in Brazil freaked out his family and friends by showing up at his own funeral this week.  Truth is, the guy in the coffin was thought to be another, whose name was Gilberto.  There was no relation between Gilberto and the dead person, but obviously their appearance was pretty similar.  The facts came out when Gilberto was walking down the street a few hours before his scheduled burial when one of his friends saw him and told him “ that his family was mourning him”.   He then ran to the funeral home and surprised everyone.  No word on who the real dead person was.

Sometimes it pays to go over the fundamentals.  All great athletes go over the fundamentals again and again.  Delta is probably the most fundamental and watched greek in options.  There are a few definitions for delta so let’s just do a quick review.  Delta measures the exposure a particular option has to a one point movement in the underlying.  For example, if XYZ 100 call has a delta of 40, this means that if XYZ moves up $1 the price of the call will move up by $.40.  Conversely if the stock moves down by $1 then the price of the call will decrease by $.40.  Deltas of puts behave the same only in the opposite direction with the put increasing by the delta as the stock falls and decreasing as the stock rallies.  Delta can also be thought of as the probability of the option finishing in the money at expiration.  For an option with a delta of 20, or .20 if not using the multiplier terminology, the market is giving that option a 20% probability of finishing in the money by expiration.  At the money options have a 50 delta, meaning that there is a 50/50 chance those options finish in the money.  Finally, the delta can be thought of as the hedge ratio.  This tells us how much stock or opposite number of deltas we need to offset our exposure to the underlying.  For example, if we have ten 30 delta calls we would have a total delta of 300.  This is our delta exposure to movement in the underlying.  To offset this risk we might look to sell 300 deltas.  Market makers often use this number to hedge their immediate delta risk after making a trade.  One last thing to remember.  Deltas are model derived mathematical computations.  They are based on inputs into the model.  As those inputs change, such as time, implied volatility or price of the underlying, the delta can change.  Think of it as a snapshot in time.  But like the weather, it can change quickly.

 

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