Tycoon Report Crowe Delta

(2009-07-14) What is Delta? This Answer Changed My Trading Life Forever (Part 1) Learning about delta and using it to make better trades is not really complex, so don't be intimidated. Just remember the two most important things: 1) If you sell your stock and buy call options to replace it, then buy "in-themoney" call options. 2) Only buy one call option for every 100 shares of stock that you own (or, would want to own). In other words, if you have 100 shares of Capital One Financial (COF), and want to close the position at $21.60, you will have $2,160. To establish an option position, you should buy only one call option contract (which represents 100 shares). If you buy the COF Jan 15 Call and pay $8 per contract (an $800 investment), then you should put the remaining $1,360 in a safe, interest-bearing security, such as a money-market fund or Treasuries. The "delta" of an option measures how much the option changes in price when the underlying security moves one point. The delta of a call option is a number that ranges from 0.00 to 1.00, and the delta of a put option is a number that ranges from -1.00 to 0.00. Hint: A call with a delta of 0.70 implies virtually the same thing as a put with a delta of -0.70. You will notice that when a call option is far out-of-the-money (for example, the XOM Jan 95 Call is 30 points out-of-the-money), (Let�s say that ExxonMobil (XOM) is trading at $65 per share, and the XOM Jan 65 Call is selling for $5.) it will either move only slightly, or not move at all, when the stock rises by one point. The delta of this FAR out-of-the-money call is only 0.04. So theoretically, if XOM moved up by one point, the price of the $95 calls should advance by 4 cents. Now, that might seem like a lot in terms of the percentage gain since the theoretical value of this far out of the money option is about 27 cents. (A 4 cent gain would be a 15% gain on a 27 cent call option). But you have to consider the fact that the spread between the bid and ask price can be much larger than the 4 cent gain in the option (so you can still end up with a losing position). *** The rule of thumb here is the higher the delta is, the more likely it is the option ends up profitable. *** And out-of-the-money options have the lowest delta, and in-the-money options have the highest delta. So you'd want to avoid the out-of-the-money option that has the delta of 0.04 like the plague. On the other hand, if the stock is trading far above the call option�s strike price -- or, said differently, the option is deep "IN-the-money" (i.e., the XOM Jan 45 Call, which is 20 points

in-the-money with the stock trading at $65), then the call option would likely have a delta of 0.96. Thus, when the stock moves up one full point, the option will likely move up 96 cents. (Almost point-for-point, aka trading at "parity" with the stock.) A put option would work the same way whereas, if XOM moved down one point, a PUT option that has a delta of -0.70 would move up by 70 cents. 2 Important Notes 1) An option�s delta changes as the price of the stock changes. This is because the deeper in-the-money that an option becomes (due to the price movement of the underlying stock,) the higher the delta becomes. So don't mistakenly think, if a call option has a delta of 0.50, that the call option would only move up by 5 points if the stock moves up by 10. That is incorrect because, again, the call option's delta increases as the option moves further above its strike price. 2)

Today we are only discussing delta. But an option�s price (and the option's delta) can be affected by other factors. The two major factors that impact an option's price and delta are "time decay" and a change in "volatility" of the underlying stock, Exchange-Traded Fund, index, etc. ** Replacing Stock with Options vs. Gambling with Options ** No matter how much money you are putting at risk, the odds of success should be good. If odds favor a loss, why invest $1? We must look at our investment portfolio as a business, and not a lottery ticket. ** Is Purchasing Out-of-the-Money Options Ever a Good Trade? ** No. More specifically, not if you're purchasing those options by themselves. However, if you buy them as a hedge, or as part of an multi-leg option position, that's a different story. But today, we are talking about stock replacement, which just involves buying an option instead of a stock. I'm going to show you how to take less risk than the traditional stockholder. First, you should understand that an out-of-the-money call option is an option that has a higher strike price than the current price of the stock. (With put options, it's the opposite. With puts, the out-of-the-money options are those with a strike price that is lower than the stock price. But let's stick with call options in our examples.) Many option traders lose money trading out-of-the-money options because they are overly confident in their prediction.

For example: They may think a stock will trade from $65 to $80 in a given period of time. But most of the time, markets and stocks trade plus one or minus one standard deviation from the mean. That is why "time decay" tends to be a factor that new, out-of-the-money option, traders learn about very quickly (and painfully). An out-of-the-money option�s delta will trend toward zero as time passes. And remember, the lower the delta is, the less the price of the option will be impacted by the movement in the stock. Therefore, the underlying stock can trade much higher over time, but the call option with a very low delta could still trade lower, even to zero, even though the stock traded higher. Trading with (what I consider to be) a Low Delta The Low-Delta 'POSITIVE' Argument A wise man once told me that the traders who make the HUGE profits like that are the same ones that take LOTS of huge losses. The Low-Delta 'NEGATIVE' Argument I usually don�t like to buy an option with a low delta unless I am covering (hedging) myself against a significant stock movement/loss. (Such is the case when using a protective put.) There are two main reasons why, and both reasons spell a higher risk with lower delta. The first is one that most people understand; the second is what many people overlook. ** 1) The lower the delta, the more extrinsic value your option contract consists of. ** Remember: The extrinsic value (or time value) portion of an option is at the mercy of the clock. Time decay has zero effect on the intrinsic value portion of my options premium. That's why we like to trade in-the-money options that have minimal extrinsic value (time value). By purchasing an option that has a high delta, I can significantly reduce the effect that time decay has on my option's value (or the option's premium). ** 2) Starting the wrong direction. This is what an or only have a slight

with a high delta reduces your loss when the stock moves in ** alarming number of option traders either don�t understand, understanding of.

In other words, you stand to lose a lot less by owning the call option. This is especially true when you are talking about an option that has an expiration day further out than 90 days. (Remember, 90 days before expiration is when the extrinsic value decay tends to speed up.) NOTE: When you buy an option strictly for the upside (and you aren�t using it for hedging purposes), you should always give yourself extra time for it to work. Try to buy it with an expiration month that is at least ***** 90 days ***** after the time that you wish to sell it.

***** Buy More Delta, Lose Less if Trade Goes South ***** When you buy options with a high delta (which are deep in-the-money) and the stock trades lower, your option loses less value than the stock does!

(2007-05-10) The Invaluable Understanding of Delta, (Part II) I told you that by purchasing deep in-the-money options, you give yourself a high delta, resulting in an option that moves up in value more (point wise) than an option with a low delta as the stock trades deeper and deeper in-the-money. So, the deeper in the money you go, the more the movement in the stock�s price will be reflected in the option�s price. But that works on both sides, which is why you don�t want to go too far in-themoney. You have to have a balance between buying deep in-the-money calls, and still staying relatively close to the strike price, because if you buy a call that is too far in-the-money, you can not only make 98 cents on a 1-point gain in a stock, but you can lose 98 cents on a 1-point loss in the stock. What you want to do is position yourself so that if the stock moves up several points, 85-90% of that gain will reflect in the price of your call option, but if it moves down several points, you only want more like 50 or 60% of the loss reflecting in your option. How do we do this? When I buy a call or a put option to open a trade (which is the most basic form of options trading), I usually buy an option that is anywhere from being ** 2-5 series ** in-the-money, depending on how * volatile * the stock�s price is, and therefore how much * time value * the option on the stock has. Usually the option that I buy will have a delta of about ** 0.75-0.85. ** The idea is to buy an option that: a) Has little extrinsic value (aka time value) b) Will still give you a decent return c) Has at least *** six months *** left before expiration

(2007-05-17) The Invaluable Understanding of Delta, (Part III) Some people even think of the delta as being the probability of the option being in-the-money at expiration. (Delta of 20 indicating that there is a 20% chance of the option being in-themoney at expiration.) If you want to benefit from this feature, you should trade the options that have at least 3 months left before the expiration day. If you hold the Cisco options for a few months, and you realize that expiration day will be in 3 months, then what you should do is sell the calls that you own, and buy the calls with an

expiration day that's further out. This way you can keep the feature of the call options gaining more and losing less. * Remember: Intrinsic value is the amount that an option is in-the-money. Extrinsic value is the rest. * "Extrinsic value", aka "time value" which was affected by all of the other factors such as: a) Time remaining b) Volatility c) The risk-free interest rate d) Dividends that the stock pays. These factors are also what affects the measurement called "delta". The delta is not a factor. The delta is the conclusion or a result of the varying factors mentioned above. - An option contract with a lot of time remaining has a delta that changes rather moderately as the underlying stock moves from out-of-the-money to in-the-money. - On the flip side, a short-term option�s delta will change dramatically as the underlying stock moves from out-of-the-money to in-the-money. For the option that has a week left until expiration (very short-term,) the option�s delta rises to nearly 1.00 very quickly when it moves in-the-money. The option�s delta drops to zero very quickly when the option moves out-of-the-money. A SIDE NOTE: Did you notice that the option with the most extrinsic value is always the option which is at-the-money? So if you were the seller of the option, in order to collect a premium in the case of a covered call, you would be taking the most advantage of time decay by selling the at-the-moneys. The deterioration of extrinsic value known as time decay comes into play mostly in the last three months remaining on the life of the option contract.