Can you explain the term "DELTA"? (March 7, 2002)
Delta is the measure of how much an option price changes for every move up or down in the underlying security. A delta of 1.0 means that for each $1 move in the underlying stock, the option moves $1 as well. A delta of 0.50 means for every $1 move, the option moves $0.50 in the same direction. Put options have negative deltas, e.g., -0.50. They work the same way: when you own a put option with a -0.50 delta, if the stock moves up $1, the put option falls $0.50; if the stock falls $1, the put option rises $0.50.
We use deltas on covered calls to determine where to put our buyback order on calls that we sold. We know that the stock has support at a certain level, say $3 below where the stock currently is. It is topping, so we want to sell some calls. If the calls we want to sell have a 0.7 delta, a $3 drop to support by the stock would drop the price of the option by 2.10 ($3 x 0.7=2.10). So, we subtract 2.10 from the ask price of the option at the time we sold it to determine the ask price (the price at which we would have to buy it back) of the option when the stock hits the support level. That way we can do it all automatically. We discuss this great way to use covered calls to our advantage to generate cash in cash accounts and in IRA's in our online seminars.
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