Last week we gave a very high pressure quiz ( just joking) on the very important Greek, DELTA. This Greek is crucial in managing price risk. Today we will go over the Quiz.
#1 Delta refers to PRICE RISK. Delta and Gamma are the two Greeks that deal with the price risk of options.
#2 When you buy a call option, the delta decreases as the stock price goes up? FALSE. When you buy a call option , the delta increases as the stock goes up. That’s because the call becomes more valuable as the stock increases.
#3 The delta of a January at-the-money call is higher than a November at-the-money call? TRUE. Because there is more time left there is greater potential for movement and therefore a bigger delta.
#4 You buy the November 175-180 call debit spread for $3.00. The delta of the 175’s is 63 and the delta for the 180’s is 53. Approximately, what will be the price of the spread if the stock goes up $1.00? You just add the delta difference between the strikes to the price of the spread. Delta difference is 10 PLUS the $3.00 price of the spread = $3.10
#5 Does an increase in implied volatility affect a 50 delta or 75 delta option more? 50 delta is the answer. The at-the money 50 delta has more time premium or extrinsic value than a 75 delta option. Volatility changes affect the time premium or extrinsic value of an option, not the intrinsic value. Therefore, any volatility change will affect the at-the-money 50 delta more than the 75 delta in-the-money option because it has more time premium or extrinsic value.
#6 What is the delta of 100 shares of stock? Answer is 100. If you own 100 shares of XYZ stock and it goes up $1.00 , you make $100. If you own an option at $10.00 with a delta of 100, if the underlying stock increases $1.00, the option price will also go up $1.00 to $11.00.
#7 What Greek determines how deltas will change over time? Answer is Gamma. If XYZ stock is at 120 , I buy 1 November 120 call for $4.00. This at-the-money option has a delta of 53. The gamma is 4. What does this mean? If XYZ goes from 120 to 121 , the delta of the call will go from 53 to 57, the delta plus the gamma.
#8 Do at-the-money deltas increase or decrease as you get closer to expiration? How about out-of-the-money options? Delta describes the probability an option will finish in-the-money at expiration. If the stock is at 120 and I buy the November 124 out-of-the money calls with a delta of 40, the deltas will decrease over time because there is less probability the November 124’s will be in the money. With the stock at 120, if I buy the November 120 at-the-money calls, the deltas will actually increase a bit as we are around 120 because at expiration, if stock is above 120 the deltas will be 100 ( stock), and below 100 the deltas will be zero (worthless).
#9 Will the deltas of an at-the-money call calendar increase or decrease as you get closer to expiration? As a calendar gets closer to expiration, the position deltas will get shorter as your short option goes in the money and the position deltas will get longer on a call calendar as your short option goes out-of-the money.
#10 Why are the position deltas of an Iron Butterfly always short when you start? Iron butterfly example. XYZ 100. Sell 1 100 call and buy 1 110 call. Sell 1 100 put and buy 1 90 put. The out-of-the-money 90 put will have a higher delta than the out-of –the money calls usually and the at-the-money call deltas will usually be a bit higher than the puts.
Good luck trading. Have a nice weekend.