Options are a handy way to profit. Yet they can be confusing… especially when you’re starting out.
If you’re bullish on a stock, one strategy is to buy a call option. A call option increases in value when the underlying stock rises.
And if you’re bearish, you could buy a put option. A put option increases in value if the underlying stock falls.
However, folks often struggle to understand how much an option’s value should change when the underlying stock moves.
The stock might move a few percent… but the option hardly budges. Or maybe the stock barely twitches… yet the option leaps.
Once you comprehend the dynamics at play, you will almost certainly become a better options trader.
So let’s check them out…
Understanding Delta
“Delta” captures the relationship between an option and the stock price.
Delta tells you how much an option’s price should move for a given change in the underlying stock price. You can find it quoted on your trading platform whenever you enter an option trade.
Deltas for call options are positive, ranging from 0.0 to 1.0. The call option should increase in value when the underlying stock rises.
Deltas for put options are negative, ranging from 0.0 to –1.0. The put option’s value should decrease in value if the underlying stock price rallies.
Delta tells you how much the option’s value should change during that rally (or a fall).
For example, a call option with a delta of 0.5 means that the option should increase by around half the stock price’s move.
So, if the stock price increases by $20, the call option should increase by $10. Conversely, if the stock price dropped by $10, you’d expect that call option to fall by $5.
You typically find a 0.5 delta with an at-the-money (ATM) option. That’s an option where the strike price is very close to the current stock price.
However, delta can have limitations if you use it in isolation. That’s where another tool can help you…
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Option Sensitivity
One of the challenges of delta is that its value constantly changes. And the rate of that change can vary.
That’s where an option’s “gamma” fits into the picture.
Gamma gauges an option’s sensitivity to movements in the underlying stock. Again, you’ll find gamma quoted (along with delta and other “Greeks”) for each available option on your trading platform.
The higher the gamma is, the more sensitive the option’s price is to moves in the stock price. For someone buying an option, this can be a big help.
Higher gamma means that the option’s delta could increase in value even if there’s only a small move in the stock price. And that can rapidly boost the option’s value.
Understanding these two concepts can help you follow the moves of your option much better.
And one final note… Gamma increases the closer the option gets to expiry – especially on the day of expiration.
We’ve put that dynamic to use with our “zero days to expiration” (ODTE) trading strategy at The Opportunistic Trader. 0DTE options have taken the market by storm with their huge potential returns. They account for almost half of the options activity on the S&P 500.
If you’d like to hear me talk about 0DTEs and a host of other trading strategies and market analysis, be sure to check out my free podcast, Trading With Larry Live. It runs Monday through Thursday at 8.30 a.m. ET.
I’ll also discuss what I expect to drive the market that day… and how you can take advantage of the coming moves.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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