First, as always, I am not a financial advisor. I am just sharing my journey trading options. I hope you find it helpful. Always consult with a financial advisor about your situation and goals before adding any trading strategy to your personal plan.
I’m assuming you are familiar with put credit spreads, or you can read my part 1 beginner option strategy video where I introduce them.
In this post, I am going to talk about delta. Delta is one of what are called the option greeks. These are just pieces of the model used to predict option prices. These pieces can be a useful gauge of how a position will respond to changes in the market. In the case of delta, you are seeing how your P&L will react to a move up or down in the underlying.
To illustrate this, I am going to show a put credit spread on AMZN. I have no opinion on AMZN, just picking it at random. Here, we are looking at thinkorswim’s analyze feature. The light blue line is your P&L at expiration. That’s usually the plot you see when people discuss put credit spreads. At expiration, anywhere above the 120 short put you make max profit.
The purple line is the “right now” line. That is, at the current market price of AMZN, the P&L is 0. That’s what we would expect if we just put this trade on. With the put credit spread, a move up is a move away from the risk so as the “insurer”, we make a profit. Moves down towards the risk increase the price of the insurance since the risk is greater. So a move down hurts us and our P&L is a loss.
Put Credit Spreads benefit from moves up in the market, but they are still short options trades and they also benefit from the passing of time. As each week passes, if the market is still in the same place, there is less time for it to drop below the strike price. Less time means less risk and less risk means the option contract is cheaper. So that’s another source of P&L for this trade.
In options terminology, we call the “right now” line the “T+0” line. That is, the current time + 0 days. Thinkorswim lets us plot additional lines in the future such as T+14, T+28, etc. This is what that looks like. So you can see that as time passes, if the market stays where it is, the trade still makes money.
OK, now back to delta. When you look at the P&L effect of a move up or down on the T+0, this can be characterized by how much the option spread price changes for a $1 move in the underlying. 1 delta means the position makes $1 on a $1 move up in the stock. This will feel like owning 1 share of the stock. Here we have 8.6 delta of AMZN. This will feel like 8.6 shares of a $127 stock or roughly $1000 worth of AMZN. The margin the broker will require is around the max loss of $360. So it’s important to be aware if you trade these put credit spreads that you can have a lot of leverage on if you aren’t paying attention to it.
Each option leg in a spread has it’s own delta. You can see this in the option chain. The delta for the spread is calculated by adding or subtracting each of these deltas up to a “net delta” for the spread. That’s the delta we were just looking at on the analyze tab. Delta also has the 100x multiplier for equity options. In thinkorswim, the chain is showing decimal delta but on the analyze tab it has already multiplied by 100. Just something to be aware of in thinkorswim.
I should add, there are other things that influence option prices like vega. Vega is another Greek we will talk about later. All of these greeks and analyze plots are more like a weather forecast than an exact science.
OK, so that was a quick introduction to the first Greek, delta. This sets us up to talk about “delta neutral” strategies in future.