Best of the Week
Most Popular
1. 2019 From A Fourth Turning Perspective - James_Quinn
2.Beware the Young Stocks Bear Market! - Zeal_LLC
3.Safe Havens are Surging. What this Means for Stocks 2019 - Troy_Bombardia
4.Most Popular Financial Markets Analysis of 2018 - Trump and BrExit Chaos Dominate - Nadeem_Walayat
5.January 2019 Financial Markets Analysis and Forecasts - Nadeem_Walayat
6.Silver Price Trend Analysis 2019 - Nadeem_Walayat
7.Why 90% of Traders Lose - Nadeem_Walayat
8.What to do With Your Money in a Stocks Bear Market - Stephen_McBride
9.Stock Market What to Expect in the First 3~5 Months of 2019 - Chris_Vermeulen
10.China, Global Economy has Tipped over: The Surging Dollar and the Rallying Yen - FXCOT
Last 7 days
QE Forever: The Fed's Dramatic About-face - 21st Feb 19
Gold Technical Perspective – Why So Bullish? - 21st Feb 19
Sheffield "Mi Amigo" Memorial Fly Past at 8.45am on 22nd Feb 2019 - 20th Feb 19
Here’s The Real Reason You Stress About Money - 20th Feb 19
Five Online Marketing Predictions that will Matter in 2019 - 20th Feb 19
Has Gold Price Reached Upside Resistance Near $1340-1360? - 20th Feb 19
So Many Things are Not Confirming Stock Market Rally - 20th Feb 19
Forex Trading Management: The Importance of Being Prepared - 19th Feb 19
Gold Stocks are Following This Historical Template - 19th Feb 19
Here’s Why The Left’s New Economic Policies Are Just Stupid - 19th Feb 19
Should We Declare Emergency for Gold? - 19th Feb 19
Why Stock Traders Must Stay Optimistically Cautious Going Forward - 19th Feb 19
The Corporate Debt Bubble Is Strikingly Similar to the Subprime Mortgage Bubble - 18th Feb 19
Stacking The Next QE On Top Of A $4 Trillion Fed Floor - 18th Feb 19
Get ready for the Stock Market Breakout Pattern Setup II - 18th Feb 19
It's Blue Skies For The Stock Market As Far As The Eye Can See - 18th Feb 19
Stock Market Correction is Due - 18th Feb 19
Iran's Death Spiral -- 40 Years And Counting - 17 Feb 19
Venezuela's Opposition Is Playing With Fire - 17 Feb 19
Fed Chairman Deceives; Precious Metals Mine Supply Threatened - 17 Feb 19
After 8 Terrific Weeks for Stocks, What’s Next? - 16th Feb 19
My Favorite Real Estate Strategies: Rent to Live, Buy to Rent - 16th Feb 19
Schumer & Sanders Want One Thing: Your Money - 16th Feb 19
What Could Happen When the Stock Markets Correct Next - 16th Feb 19
Bitcoin Your Best Opportunity Outside of Stocks - 16th Feb 19
Olympus TG-5 Tough Camera Under SEA Water Test - 16th Feb 19
"Mi Amigo" Sheffield Bomber Crash Memorial Site Fly-past on 22nd February 2019 VR360 - 16th Feb 19
Plunging Inventories have Zinc Bulls Ready to Run - 15th Feb 19
Gold Stocks Mega Mergers Are Bad for Shareholders - 15th Feb 19
Retail Sales Crash! It’s 2008 All Over Again for Stock Market and Economy! - 15th Feb 19
Is Gold Market 2019 Like 2016? - 15th Feb 19
Virgin Media's Increasingly Unreliable Broadband Service - 15th Feb 19
2019 Starting to Shine But is it a Long Con for Stock Investors? - 15th Feb 19
Gold is on the Verge of a Bull-run and Here's Why - 15th Feb 19

Market Oracle FREE Newsletter

The Real Secret for Successful Trading

Learning How Delta Creates Profits When Trading Gold Options

Commodities / Gold and Silver 2010 Aug 18, 2010 - 02:06 PM GMT

By: Chris_Vermeulen

Commodities

Best Financial Markets Analysis ArticleLast week’s articles focused specifically on the option Greek Theta. This week we will shift gears and adjust our focus on Delta, another fundamental tenet of option trading. The official definition of Delta as provided by Wikipedia is as follows:

Δ, Delta – Measures the rate of change of option value with respect to changes in the underlying asset’s price.


Delta has a significant impact on the price of an option contract(s). When a trader is long a call contract, Delta will always be positive. Likewise, if an option trader owns a put contract long, Delta will always be negative. As option contracts get closer to the money their Delta increases causing the option contract to rise in value rapidly as the option gets closer to being in the money.

Clearly Theta has an adverse impact on a trader who is long a single options position (own options long with no hedge or spread), however Delta is extremely dynamic and is one of the major factors directly responsible for option pricing as the price of the underlying changes throughout the trading day.

If an option is deep in the money, the option contract will have a higher Delta and will generally act similarly to actually owning the individual stock. For a deep in-the-money GLD call that has a Delta of +.80, the first dollar GLD rises by then the value of the GLD call options increases by roughly $0.80 or $80.

If the delta is 0.80, this essentially means that the GLD call option will increase in value 0.80 ($80) for every $1 that the GLD ETF increases. As the GLD option goes deeper into the money, the Delta will typically rise until it nearly produces the same gains as the GLD ETF until the delta asymptotically approaches 1.00 and the option moves in lockstep with the underlying. While my next article will continue to help explain Delta, it is important to understand how Delta can enhance a trader’s return when trading options with a specific directional bias.

While options exist for the gold futures contract, typically if I want to trade gold I utilize the GLD ETF. The primary reason is that the ETF offers liquid options, which makes it easier to initiate spreads and multi-legged orders. If options are thinly traded, the bid ask spread is almost always wide making it more difficult to get a good fill and a good overall price. Most option traders stay away from underlying stocks that have illiquid options.

In order to better illustrate how an options’ Delta can create profits, I will use GLD as an example. Keep in mind, I am not advising any traders to buy or sell options naked. I only trade options using strategies that help mitigate various risks to my capital. Theta (time) risk, volatility risk, and market risk are not being considered as this is merely an example to illustrate the power of Delta.

Recently Gold and subsequently GLD suffered a pretty significant pullback. GLD broke down through a major horizontal trend line and the daily chart was extremely bearish. Just when a lot of traders were preparing to get short GLD, buyers stepped in and pushed GLD’s price back above the support area. The GLD daily chart listed below illustrates the breakdown and subsequent failure and a powerful rally followed.

Let us assume for contrast that an option trader and an equity trader each want to get long GLD. The equity trader buys 200 shares of GLD at $115/share. Assuming the equity trader does not use margin, the total trade would cost around $23,000 not including commissions. The option trader decides to utilize delta and purchases 5 October 107 calls which in our example cost $900 per contract for a grand total of $4,500 not including commissions.

We will assume the October 107 calls have a Delta of 1.00. When a call option has a delta of 1.00, it essentially means that the owner of the call is going to get 100% of the move reflected in the premium of the option he/she owns. Thus if GLD increases by $1, the value of the option would increase $1 all things being held constant.

This is where Delta really shines; it shines even brighter than gold in this illustration. Both the equity trader and the option trader have a profit target of $118/share. A few days later GLD reaches $118/share and both traders close their trades with profits. The equity trader made $3/share which relates to a total gain of $600, or around 2.60%.

The option trader realized roughly 95% of the move, meaning around $2.85. The option trader had five total contracts for a total gain of $1,425 less commissions. The total gain for the options trader was over 31% less commissions.

Keep in mind, the option trader only had $4,500 of maximum risk while the equity trader was risking over $20,000. The option trader made over 100% more money, while risking only 25% of the total capital required by the equity trader. Behold, the power of Delta!

If you would like to continue learning about the hidden potential options trading can provide please join my FREE Newsletter: www.OptionsTradingSignals.com 

 J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. J.W. strives to reach traders that are missing opportunities trading options and commits to writing content which is not only educational, but entertaining as well. Regular readers will develop the knowledge and skills to trade options competently over time. Jones focuses on writing spreads in situations where risk is clearly defined and high potential returns can be realized. 

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.  


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules