How to Use Delta to Time Call-Buying Decisions - dummies

How to Use Delta to Time Call-Buying Decisions

You can use delta to time your call buying. Delta measures the amount by which the price of a call option will change, up and down, every time the underlying stock moves 1 point.

In a day-trading situation, it’s recommended that you trade the underlying stock. This strategy follows the key concept of using delta: The shorter the term of the strategy, the greater your delta should be. The delta of the underlying stock is 1.0. Thus, the stock is the most volatile instrument and is best suited for day-trading.

How long you expect to hold an option determines in part which option to buy. Here are some general rules to follow when using delta to time your call buying:

  • For trades that you expect to hold for a week or less, use the highest delta option you can find, because its moves will correlate the closest with the underlying asset. In this case, short-term, in-the-money options are the best bet.

  • For intermediate-term trading, usually weeks in duration, use options with smaller deltas. It’s recommended that you use at-the-money options for this time frame.

  • For longer-term trading, choose low-delta options, either slightly out-of-the-money or longer-term at-the-money options.