Delta is a number that tells us how much the price of an option might change when the price of the option’s underlying stock or index changes $1.00.
Most stock and index options have a $100 multiplier, meaning when the option’s price goes up, for example, from .50 to 1.50, its value as increased by $100. When we combine that $100 multiplier with delta, we see how many dollars of profit or loss the option will give us if the stock price moves $1.00. So, if we are long 1 option whose price starts at 2.00, has a delta of .30 and the stock price goes up $1.00, theoretically the price of that option will rise to $2.30, and we would see a $30 profit on that option.
If we had 10 of those options, we would see a $300 profit. Now, if the stock drops $1.00, that option would drop from $2.00 to $1.70, we would lose $30 on 1 option, or $300 on 10 options. We can then say that 1 option has a “position delta” of 30, and that 10 options have a “position delta” of 300. A way to interpret that position delta is that it’s the number of shares that the option position “acts like” when the stock price changes $1.00. In other words, the 10 options “act like” 300 shares of stock because they lose $300 if the stock price drops $1.00, just like 300 shares of stock would.
When we talk about “delta hedging”, we’re looking to reduce our position deltas so that the loss is mitigated if the stock price moves against the position. For example, if we shorted 100 shares of stock as a hedge against those 10 options, the position delta would drop from 300 to 200. You can use stock, single options and option spreads as a way to hedge the delta of an existing position.
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