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Can You Help Me Exploit The Delta Of An Option?

Posted by Pete Stolcers on December 9, 2007

Option Trading Question

Where can I find real time delta calculations for various options? CBOE has "freeware" that computes Greeks, but even with this utility one has you input multiple variables. This makes it impossible for someone to exploit aberrations in delta numbers given all the input variables. What do you think?

Option Trading Answer

I think that most non-professional traders put WAY too much emphasis on the Greeks.

First let me address your need for the information. http://www.ivolatility.com, http://www.optionvue.com or http://www.esignal.com have the data. You can also get it free through most brokerage firms (optionsXpress, TradeKing, Interactive Brokers, TradeStation...).

The deltas are only a theoretical value. They estimate the dollar change in the option for every dollar change in the underlying stock. There is no steadfast rule that says the option has to move in lock-step with the delta. In fact, the delta changes with the rise or fall in the underlying stock. That change in delta is measured by a Greek called gamma.

The Greeks are theoretical values and there is not an “aberration” to exploit. You can’t “hit” the bid and sell a delta that is too high.

Don’t confuse the Greeks with implied volatility. Implied volatility is real and it is embedded in the price of the option. Now there’s something tangible that can be bought or sold! An option can be mispriced and if there is an aberration, it can be exploited - BY A PRO. Large institutions with research teams, complex auto-quote systems and Market Makers do this efficiently. I have written about this in, “Which Option Trading Arbitrage Strategy Is The Best?”

Realize that the quote systems are trying to calculate the Greeks on a best efforts basis. Should they use the option bid, the ask, the last trade, or a blend? The option price used in the calculation is arbitrary and it has a huge impact on the value.

The Greeks should only be used as a guideline to determine the best strategy given your opinion on the duration and magnitude of the expected move in the underlying. There are scenario analysis programs that will calculate your P&L based on various price movements in the stock. You assign probabilities to each expected outcome and you arrive at an expected value for the trade.

I tell my subscribers to focus on getting the market direction right. Then find stocks with relative strength or weakness. Once you have formulated an opinion, analyze the options. Keep the option analysis simple. The options are a reflection of your opinion. Know when your opinion was right and when if was wrong and act according to exit the trade.

Option Trading Comments

  • On 05/13, Donna L said:

    I just read an analyst recommendation to sell Jan $120 calls in Visa (V) and buy Jan $380 calls in MasterCard (MA), because Visa options are more expensive than MasterCard. It said, “The trade takes advantage of the inverted call skew on (Visa) and the wide vol spread between (Visa) and (MasterCard). If the spread tightens, you gain as the trade is delta neutral.

    I thought selling naked calls was the riskiest options investment. Is this this strategy reasonably effective?

  • On 05/13, Pete Stolcers said:

    This is similar to a pairs trade where the trader goes long the strong and short the weak within a sector or group.

    It is a sophisticated strategy and for margin purposes, you are naked short calls. To receive option approval for this level of trading, the account holder needs to have a high net worth and they need to be very experienced. The OCC has outlined minimum criteria that need to be met.

    If news drives Visa higher and Mastercard does not participate in the rally, the trade poses a great deal of risk. This is unlikely to happen, but it can.

    From a professional trading standpoint, yes, the trade makes sense.

  • On 06/28, derya baykal said:

    I thought selling naked calls was the riskiest options investment. Is this this strategy reasonably effective?

  • On 06/30, Pete Stolcers said:

    If you are a novice, I would not suggest selling naked calls. Takeovers are the biggest risk and the stock can double overnight.

    Brokerage firms will notapprove you for naked writing if you do not have at least $1 million in net worth and extensive option experience.

    Yes, selling naked calls is the riskiest option strategy. Can you make money? Yes, as long as the stock goes down. Get good at shorting stock before you attempt this strategy and at least buy a far OTM call to limit your risk.

  • On 08/06, John Serniak said:

    I have a position of several Call options, and the price behavior in the market is baffling me.  Shortly after the market opened, the underlying stock went up 4 points, and my position was making about $10.  As the day progressed, the underlying has run up 6 more points to about 10 up, and I am LOSING $150.  can you help me understand why on a fairly good move, I am losing money on calls and the direction was correct?

  • On 08/07, Pete Stolcers said:

    I’m sorry, but I would need more information to give you an accurate reply. Please provide the time, date, underlying stock, strike price, expiration month and price. Every situation is different and the surrounding circumstances are critical.

    Off the top of my head, I’m guessing that it was an earnings play. Once the results are released, the implied volatility drops and you could lose money even if the stock is heading in the right direction.

  • On 11/22, Just said:

    What is OCC? (something tells me it’s a dumb question:D)

  • On 11/26, Pete Stolcers said:

    Options Clearing Corporation (OCC). They clear all option trades and determine exercise/assignment, position limits, margin requirements and adjustments (stock splits, sppin-offs).

  • On 04/05, john molloy said:

    GAMMA FRUSTRATIONS:why does the gamma of stock options for an at-the-money option increase dramatically as the time until expiration decreases and the gamma of in-the-money or out-of-the-money options decreases under the same time scenario?

  • On 04/05, Pete Stolcers said:

    Don’t over think this. Gamma is a second derrivative. It measure the change in Delta.

    first of all, the Gamma for an ITM option near expiration can only go down because it is trading at parity (Delta of 1).

    For At the money or out of the money options near expiration, the premiums are small and the likelihgood of a big move has been discounted. When a big move happens, the options jump higher. The delta might change from .2 and rise to .5 That Gamma would pop as well.

    Think of the stock option that was $3 out of the money with 2 days left that jumps $4. The options fo from 0-60 in nothing flat.

    In order to have a big spike in Gamma, the Delta has to be low.

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