The delta is a ratio comparing the change in the price of an asset, usually a marketable security, to the corresponding change in the price of its derivative. For example, if a stock option has a delta value of 0.65, this means that if the underlying stock increases in price by $1 per share, the option on it will rise by $0.65 per share, all else being equal.
Delta values can be positive or negative depending on the type of option. For example, the delta for a call option always ranges from 0 to 1 because as the underlying asset increases in price, call options increase in price. Put option deltas always range from -1 to 0 because as the underlying security increases, the value of put options decrease. For example, if a put option has a delta of -0.33, if the price of the underlying asset increases by $1, the price of the put option will decrease by $0.33. Technically, the value of the option's delta is the first derivative of the value of the option with respect to the underlying security's price.
Call option delta behavior depends on whether the option is "in-the-money" (currently profitable), "at-the-money" (its strike price currently equals the underlying stock's price) or "out-of-the-money" (not currently profitable). In-the-money call options get closer to 1 as their expiration approaches. At-the-money call options typically have a delta of 0.5, and the delta of out-of-the-money call options approaches 0 as expiration nears. The deeper in-the-money the call option, the closer the delta will be to 1, and the more the option will behave like the underlying asset.
Put option delta behaviors also depend on whether the option is "in-the-money," "at-the-money" or "out-of-the-money," and are the opposite of call options. In-the-money put options get closer to -1 as expiration approaches. At-the-money put options typically have a delta of -0.5, and the delta of out-of-the-money put options approaches 0 as expiration approaches. The deeper in-the-money the put option, the closer the delta will be to -1.
A calendar spread is an options or futures spread established by simultaneously entering a long and short position on the same underlying asset at the same strike price but with different delivery months. Sometimes referred to as an inter-delivery, intra-market, time, or horizontal spread.
The typical options trade comprises the sale of an option (call or put) with a near-term expiration date, and the simultaneous purchase of an option (call or put) with a longer-term expiration. Both options are of the same type and use the same strike price.
- Sell near-term put/call
- Buy longer-term put/call
- Preferable but not required that implied volatility is low
The purpose of the trade is to profit from the passage of time and/or an increase in implied volatility in a directionally neutral strategy.
Delta hedging is an options strategy that aims to reduce, or hedge, the risk associated with price movements in the underlying asset, by offsetting long and short positions. For example, a long call position may be delta hedged by shorting the underlying stock. This strategy is based on the change in premium, or price of option, caused by a change in the price of the underlying security.
An options position could be hedged with options with a delta that is opposite to that of the current options position to maintain a delta neutral position. A delta neutral position is one in which the overall delta is zero, which minimizes the options' price movements in relation to the underlying asset. For example, assume an investor holds one call option with a delta of 0.50, which indicates the option is at-the-money, and wishes to maintain a delta neutral position. The investor could purchase an at-the-money put option with a delta of -0.50 to offset the positive delta, which would make the position have a delta of zero.
An options position could also be delta hedged using shares of the underlying stock. One share of the underlying stock has a delta of one because the value changes by $1 given a $1 change in the stock. For example, assume an investor is long one call option on a stock with a delta of 0.75, or 75 since options have a multiplier of 100. The investor could delta hedge the call option by shorting 75 shares of the underlying stocks. Conversely, assume an investor is long one put option on a stock with a delta of -0.75, or -75. The investor would maintain a delta neutral position by purchasing 75 shares of the underlying stock.
One of the primary drawbacks of delta hedging is the necessity of constantly watching and adjusting positions involved. Depending on the movement of the stock, the trader has to frequently buy and sell securities in order to avoid being under or overhedged. It can also be expensive. It is particularly when the hedging is done with options, as these can lose time value, sometimes trading lower than the underlying stock has increased. Trading fees apply to the trades made to adjust the position as well. Delta hedging primarily benefits the trader when they anticipate a strong move coming, as it primarily protects the investor from small moves.