Question

How is delta useful in determining the potential profitability of an options strategy?

Answer 1

Delta of an option is a rough measure of the probability of the stock being in the money at expiry. The delta is calculated using the Black-Scholes formula. Consider the example below:

- Stock trading at $100

- A 102 Strike one month call option trading at $1.5

- Say, the delta of this call option is 0.3

This means that there is a 30% chance that the stock trades above 102 (the strike price) at expiry. In other words, there is a 70% chance that this stock trades below 102 at expiry.

So, if you sell 102 strike call option and collect a premium of $1.5, you make a profit of $1.5 as long as the stock trades below $102 at expiry. In terms of delta, there is a probability of 70% that you make a profit.

In other words, if you want to make money by buying this option, then the stock has to trade above $102 at expiry. There is only a 30% chance of this happening.

This is how you interpret option delta.

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