Before we dive into the Delta model in Option Trading, we must briefly understand what option trading actually is. Options trading is trading of assets in the form of a contract for a specific period at a predetermined rate. For example, if you purchase an ETF stock from the market at a predetermined rate, you have the flexibility to use the stock to buy or sell for a specific period of time.
It is known as ‘derivative securities‘ due to its volatility in its prices, which has reasonable returns than most other stocks. Now, there are many factors working behind the existence of an option stock, sometimes it’s predictable and sometimes not. However, a proper way for hedging your stock is to estimate it by a reliable, due diligent risk measurement factor. Obviously, Delta is the best that you can count.
Let’s know about the risk determining factor in this article.
Usually, an option trade is calculated on the basis of it’s movement due to market volatility. Delta is the risk factor that measures an option trading based on the movement of $1 in the underlying stock. If the movement is positive (0 – 1 margin) then according to the rise or fall in the stock, delta measures the option price. For example, if a delta is 0.25 in a call option trading, then when the stock price rise about $1, the option price also goes about more $0.25, amounting to the price become $1.25. Now, if in the call option the stock goes down by $1, the stock also goes down by $0.25, amounting to $0.75.
It’s a short tem measurement that offers good returns.
In the same scenario, in put option, if stock goes negative (0 to – 1), as per the stock rise and fall of the stock, the variable will go up & down. That means, when a delta is –0.25 while the stock rise by $1, the theory suggests the price of the put option will go down to $0.75. Similarly, if the stock price fall by $1, the theory tells that the price of put will rise amounting to $1.25 here.
There are many positive benefits that investors get from delta in option trading. These are:-
- Easy Anticipation of Stocks
Delta gives the flexibility of easy anticipation of stock. So, investors can estimate accordingly.
- Computing Trading
With its advanced computing trading algorithm, it makes it optimized to see the movement of the stocks.
- Comprehensive View of Risk
Investors can get a more comprehensive view of their risk and review their reward through delta, theta, & gamma.
- Real-time Response
It’s real-time response of risk makes it more sought to the investors who get benefits through hedging portfolio.
- Common Link Between Traders and Makers
It provides a common language link between traders and market makers to communicate and negotiate the option prices.
In conclusion, delta is an effective tool that makes traders response to real-time trading volatility and future prospects of an option. By measuring risk through delta, businesses can further streamline theirs portfolio and get benefits through investment in option portfolio.