38 lines
2.8 KiB
Plaintext
38 lines
2.8 KiB
Plaintext
Chapter 25: LEAPS
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THE DELTA
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387
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The delta of an option is the amount by which the option price will change if the
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underlying stock changes in price by one point. In an earlier section of this chapter,
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comparing the differences between LEAPS and short-term calls, mention was made
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of delta. The subject is explored in more depth here because it is such an important
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concept, not only for option buyers, but for most strategic decisions as well.
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Figure 25-5 depicts the deltas of two different options: 2-year LEAPS and 3-
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month equity options. Their terms are the same except for their expiration dates; strik
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ing price is 100, and volatility and interest rate assumptions are equal. The horizontal
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axis displays the stock price while the vertical axis shows the delta of the options.
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Several relevant observations can be made. First, notice that the delta of the at
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the-money LEAPS is very large, nearly 0.70. This means that the LEAPS call will
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move much more in line with the common stock than a comparable short-term equi
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ty option would. Very short-term at-the-money options have deltas of about½, while
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slightly longer-term ones have deltas ranging up to the 0.55 to 0.60 area. What this
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implies is that the longer the life of an at-the-nwney option, the greater its delta.
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In addition, the figure shows that the deltas of the 3-month call and the 2-year
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LEAPS call are about equal when the options a~e approximately 5% in-the-money. If
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the options are more in-the-money than that, then the LEAPS call has a lower delta.
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This means that at- and out-of-the-money LEAPS will move more in line with the
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common stock than comparable short-term options will. Restated, the LEAPS calls
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will move faster than the ordinary short-term equity calls unless both options are
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more than 5% in-the-money. Note that the movement referred to is in absolute terms
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in change of price, not in percentage terms.
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The delta of the 2-year LEAPS does not change as dramatically when the
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stock moves as does the delta of the 3-month option (see Figure 25-5). Notice that
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the LEAPS curve is relatively flat on the chart, rising only slightly above horizon
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tal. In contrast, the delta of the 3-month call is very low out-of-the-money and very
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large in-the-money. What this means to the call buyer is that the amount by which
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he can expect the LEAPS call to increase or decrease in price is somewhat stable.
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This can affect his choice of whether to buy the in-the-money call or the out-of
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the-money call. With normal short-term options, he can expect the in-the-money
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call to much more closely mirror the movement in the stock, so he might be tempt
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ed to buy that call if he expects a small movement in the stock. With LEAPS, how
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ever, there is much less discrepancy in the amount of option price movement that
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will occur. |