The delta for an out-of-the-money (OTM) option is less than 50.
Understanding Option Delta
Option delta is one of the "Greeks," which are measures of an option's sensitivity to changes in various market factors. Specifically, delta quantifies how much an option's price is expected to change for every $1 movement in the price of the underlying asset.
For example, an option with a delta of 0.30 (or 30) is expected to increase by $0.30 for every $1 increase in the underlying stock price. Delta values range from 0 to 100 for call options and -100 to 0 for put options, though when discussing moneyness, the magnitude or absolute value often implicitly refers to the 0-100 scale. For more general information on option delta, you can refer to reputable financial education resources.
Delta and Moneyness
The delta of an option provides a clear indication of its "moneyness" – whether it is out-of-the-money (OTM), at-the-money (ATM), or in-the-money (ITM). Moneyness describes the relationship between an option's strike price and the current price of the underlying asset.
- Out-of-the-Money (OTM): An option has no intrinsic value and would expire worthless if the underlying asset's price remained at its current level. For a call option, the strike price is above the current asset price. For a put option, the strike price is below the current asset price.
- At-the-Money (ATM): An option's strike price is equal or very close to the current price of the underlying asset.
- In-the-Money (ITM): An option has intrinsic value. For a call option, the strike price is below the current asset price. For a put option, the strike price is above the current asset price.
Delta Values for Different Moneyness States
The following table summarizes the delta ranges associated with each moneyness state:
| Moneyness State | Delta Range | Description |
|---|---|---|
| Out-of-the-Money | Less than 50 | Option has a lower probability of expiring in the money. |
| At-the-Money | Equal or close to 50 | Option's strike price is near the current asset price. |
| In-the-Money | Greater than 50 | Option has a higher probability of expiring in the money. |
Why OTM Options Have Lower Delta
Out-of-the-money options have a delta of less than 50 because they are further away from their strike price, making it less likely they will finish in-the-money by expiration. The lower the delta, the less sensitive the option's price is to movements in the underlying asset. This also reflects a lower probability that the option will expire with intrinsic value.
Practical Insights:
- Probability: A delta of, say, 20 (0.20) for an OTM option suggests a roughly 20% probability that the option will finish in-the-money by expiration, assuming a normal distribution of future price movements.
- Leverage vs. Risk: OTM options are often cheaper due to their lower delta and lower probability of success. While they offer significant leverage if the underlying asset moves sharply in the desired direction, they also carry a higher risk of expiring worthless.
- Delta's Dynamic Nature: As the underlying asset's price moves towards an OTM option's strike price, its delta will increase, reflecting the higher probability of it becoming at-the-money or even in-the-money. Conversely, if the underlying moves further away, the OTM option's delta will decrease, approaching zero.
Understanding delta, especially in relation to an option's moneyness, is crucial for traders to assess risk, potential profit, and the likelihood of an option finishing in-the-money.
