Option Greeks: DELTA (Part 3)

Go back to “Delta - Part 2”.

Although some people may not be totally agreeable, there is another way how we can “interpret” Delta.
Options Guy’s Blog posted an article about another “definition” of delta:
”Delta is the probability of the option contract being in-the-money at expiration”.

I agree that this is not the theoretical definition of Delta. I still use delta data as per the theoretical definition, i.e. how much the option’s theoretical value will change when the stock price changes by $1.
But I do feel that the other “definition” of delta has helped me to understand more about some “behavior” of delta.

For instance:

Why for ITM options, for the same strike price, the longer days to expiration, the lower the delta?
Because ITM option with more days to expiration has more time to move.
Options Guy argues that “more time to move means less likelihood of the option still being in-the-money at expiration; this translates into a smaller Delta”.

And why for OTM options, for the same strike price, the longer days to expiration, the higher the delta?
Options Guy argues that “if you’re buying OTM options, you need time for the stock to move up to the strike price. In other words, there’s a much higher probability of the underlying finishing ITM for the [longer to expiration] option than for the [nearer to expiration option]; Delta reflects that probability”.

Likewise, we can also use the same logic to answer this question:
Why a decrease in volatility will push the deltas of ITM Calls closer to 1 (-1 for Puts) and the OTM options’ delta closer to 0.
Because decreased (implied) volatility means the future stock price fluctuation is expected to be lower. As a result, for ITM options, the probability of the options to be still in-the-money at expiration will be higher, which translates into a higher Delta.
On the other hand, for OTM options, decreased (implied) volatility would lower their probability to be in-the-money at expiration. And the lower delta reflects that probability.

Hope this can help you to better understand Delta too. :)

To read about other Option Greeks, go to: Option Greeks.


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