Greeks (finance) - First-order Greeks - Delta - Practical Use

Practical Use

For a vanilla option, delta will be a number between 0.0 and 1.0 for a long call (and/or short put) and 0.0 and −1.0 for a long put (and/or short call) – depending on price, a call option behaves as if one owns 1 share of the underlying stock (if deep in the money), or owns nothing (if far out of the money), or something in between, and conversely for a put option.

These numbers are commonly presented as a percentage of the total number of shares represented by the option contract(s). This is convenient because the option will (instantaneously) behave like the number of shares indicated by the delta. For example, if a portfolio of 100 American call options on XYZ each have a delta of 0.25 (=25%), it will gain or lose value just like 25 shares of XYZ as the price changes for small price movements.

Delta is always positive for long calls and negative for long puts (unless they are zero). The total delta of a complex portfolio of positions on the same underlying asset can be calculated by simply taking the sum of the deltas for each individual position – delta of a portfolio is linear in the constituents. Since the delta of underlying asset is always 1.0, the trader could delta-hedge his entire position in the underlying by buying or shorting the number of shares indicated by the total delta. For example, if the delta of a portfolio of options in XYZ (expressed as shares of the underlying) is +2.75, the trader would be able to delta-hedge the portfolio by selling short 2.75 shares of the underlying. This portfolio will then retain its total value regardless of which direction the price of XYZ moves. (Albeit for only small movements of the underlying, a short amount of time and not-withstanding changes in other market conditions such as volatility and the rate of return for a risk-free investment).

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