The Option Greek Delta
New option traders often learn of the option Greek Delta right away as they typically start with directional call and put buying and want to know how much they could make when choosing strikes. This is because Delta represents the dollar value the price of the option will change when the stock or ETF they’re trading moves by $1.
After the new option trader realizes he or she can’t make consistent gains having to be directionally right all the time, they often turn to option selling. When it comes to selling options, Delta can be used again as a probability of an option expiring in the money. More on that in a second.
Before we talk about Delta as a probability, let’s quickly talk about the Values of Delta. Not like ethics or morals or anything, the actual number values of Delta.
The Delta of a call option can have a value between 0 to +1. It’s always a positive number as the price of the option will rise with a rising underlying.
The Delta of a put option can have values between -1 to 0. It’s always a negative number because if the underlying trades lower, the price of the option will increase.
Comparing Call and Put Delta
With any given strike price of an optionable stock, there is both a call and a put option available to trade. What’s interesting here is that if you add the absolute values of the deltas of the call and the put together, you’ll get the number 1. For example, the call option has a Delta of 0.40, the put option for the same strike will have the Delta of -0.60.
This is almost always true but as you get farther away from the money in either direction, it can be off slightly. Even though it’s not perfect all the way up and down the option chain, the relationship of Delta between the call and put of the same strike consistent.
It also leads us to using Delta as a probability of expiring in the money. This is because at expiration, either the call or the put option will be in the money (with the exception of the rare case the stocks closes exactly on the strike at expiry). Therefore the sum of the probabilities should be 100% as the sum of the absolute values of Deltas should be 1.
Using Delta as a Probability
Now that we can look at Delta as the probability of an option expiring in the money, you need to know that’s it’s not perfect. I’ll show you what I mean in the video below where we’ll examine the option chain.
Even so it is often easier to just look at Delta with a trade like a credit spread. Selling out of the money credit spreads can give you small but consistent wins in the market. If you were to look at selling a bear call spread where the call you sold had a Delta of 0.25, that would loosely tell you that there is a 25% chance that option expires in the money.
Option traders flip this logic and would prefer to say that this trade has a 75% of expiring out of the money and therefor a 75% chance of max profit.
To help ram this Delta thing home, I created a 7 minute video below called How To Use Delta In Your Option Trading that helps explain this in more detail. I hope this helps.