Two Key Tools for Understanding Options Trading

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Options can be a handy way to profit from a stock’s move. But they can be confusing when you’re starting out.

In particular, folks often struggle with calculating how much an option should increase (or decrease) in value based on the underlying stock’s moves.

And it can be tricky to judge how quickly that change should occur.

But if you use the tools that I’ll share today, you’ll be able to sidestep a lot of that confusion and become a better options trader.

So let’s check it out…

An Option’s Delta

One tool that captures the relationship between an option and the stock price is the option’s delta…

Delta tells you how much an option’s price should move when the underlying stock price moves. Any option trading platform will quote the delta for you.

Deltas for call options are positive, ranging from 0.0 to 1.0. They’re positive because the call option should increase in value when the underlying stock rises.

For put options, deltas are negative, ranging from 0.0 to −1.0. That’s because the put option’s value should decrease if the underlying stock price rallies.

And delta is especially useful in telling you how much that change should be.

For example, a call option with a delta of 0.5 means that the option should increase by about half of the stock price’s move.

So, if the stock price increases by $20, the call option should increase by $10.

You typically find a 0.5 delta with an at-the-money (ATM) option. That’s an option where the strike price is the same or very close to the current stock price.

However, while delta is a handy tool, it can have limitations when used by itself. That’s where another tool comes into play…

Options Sensitivity

One of the challenges of delta is that its value constantly changes. But how quickly it changes can vary.

That’s where an option’s gamma fits into the picture…

Gamma gauges the delta’s sensitivity to movements in the underlying stock. Again, you’ll find gamma quoted along with delta on any option 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 great help.

Higher gamma means that the option’s delta should increase even for small moves in the stock price. That can rapidly boost the option’s value (and the trade’s profits).

Gamma also increases the closer the option gets to expiry – especially on the day of expiration…

That’s one reason “zero days to expiration” (or ODTE) option trading has become so popular (where you open an option position that expires the same day). High gamma enables you to capture a potentially explosive move – and bank quick gains – if the trade goes your way.

By understanding these tools (delta and gamma) and how they work together, you can greatly enhance your chances of becoming a successful option trader.

Happy Trading,

Larry Benedict
Editor, Trading With Larry Benedict

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