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Once you start to trade in stocks and options, you’re going to want to know everything possible about what affects the price of an option. This is because we’re using options in our positions, for the money every month trades, at least.
You’d want to know exactly what it is that affects the value of the options that you own, or the options that you’re selling. Those variables include not only the strike price, the expiration of the option, but also what’s called the Greeks. The Greeks include a number of different variables. The Delta, the Gamma, the Theta, the Vega, and the Roe, which has to do with interest rates.
Let’s start with Delta. Delta is the matter of the change of the option’s value, with respect to a 1 point move in the underlying – which could either be a stock, a future, a commodity, or an ETF. Now, calls always have a positive Delta, and puts always have a negative Delta.
How do Deltas work in relation to our option positions? Well, Delta measures how much we can expect an option to increase or decrease in price, after a 1 point move in the underlying stock or ETF.
So, in this case, let’s take a look at our position statement here, for a second. Our current position states that our Diamond position has a Delta of -16. What that means is that if the Diamonds were to increase in price by 1, and we are short Delta on that position, then we would lose 15 for each 1 price increase on the Diamonds.
For every point that the Diamonds go up, we would lose 16. Think of Delta as an alternative to owning stock. If you are short the stock, what do you want it to do, in order to make a profit? You would want it to go down. If the price of our Diamonds went down by 1, we would gain a 15 profit.
You can look at the Delta as a substitute for the way the option will act, depending on whether the stock itself, the underlying, goes up, or it goes down. You can tell, based on the Delta, what will happen to your profit position.
That’s the most practical application of the Greeks – determining what will happen to your position if the underlying stock or ETF goes up by a dollar, or down by a dollar. As you can see from this, our overall position, and our overall total Delta for all of our positions, is -21.
That means we are short 21. You can think of Delta as shares of stock. We are short 21 Deltas on our entire position. If our position would move down by a point, in this position, we would gain 22 if the price of the overall market were to decline.
On our individual positions, however, the Diamonds would increase by 15.63 for each 1 point drop in the Diamonds. Our EEM position would actually gain 58 cents by an increase in the price in the EEM by $1. The IWM would increase by 23 if the price was to go up by 1. And the SPY position would increase by 33, if we were to drop a point in the SPY.
The overall aggregate total of these positions is called the net Delta. We are net Delta, and we are short Delta, by 24. To make this as easy as possible, think of this as an indicator, to tell you what would happen, if the price of your underlying position were to increase or decrease by 1.
In this case, since we are net short 24 Deltas, if our position would go down by 1, we would gain a profit of $23. If it goes up by 1, we would lose $24.
It’s only an indicator. When it becomes really significant, is when these numbers become so large that it becomes quite obvious that an adjustment is going to be necessary, so that we don’t lose a great deal of money.
When the Delta becomes -300, for example, and the market is rallying up, as it is today – it’s up 113 points, as represented by the Dow Jones Industrial Average – then we would be losing close to $300. That’s a significant position that needs adjustment, or otherwise, we could be in a position to lose a lot of money.
As it is, we’re only 19 shares short Delta. So, it’s very close to neutral. That’s not a bad position to be in, given our other Greeks