Intrinsic Value, Delta, OTM option

T

tonylim

I got confused with Option Delta. Hope someone can help.

I got the following Vega definition at http://www.optiontradingpedia.com/options_vega.htm
Options Vega - Introduction
There are 2 main component to a stock option's price; Intrinsic Value and Extrinsic Value. The price of the underlying stock relative to the strike price determines the Intrinsic Value, which is governed by Options Delta. Implied volatility of the underlying stock determines the Extrinsic Value, which is governed by Options Vega. In fact, for Out Of The Money (OTM) Options that contains nothing more than extrinsic value, their prices are 100% determined by Options Vega! When implied volatility rises, the price of stock options rises along with it. Options Vega measures how much that rise is with every 1 percentage rise in implied volatility.

Since an OTM option does not have Intrinsic Value, how is the Delta of OTM option affect option price?

Since Delta is a measure of the change in the options' price resulting from the change in the underlying stock price, when the underlying stock price change, the OTM option price will change, whether it has Intrinsic Value or not. So, is Delta changing the Extrinsic Value of the OTM option price?
 
Kind of misleading to say that the option is "100% determined by option vega".

Obviously as you say, it has delta, gamma, theta that also affects it..
 
tonylim said:
So, is Delta changing the Extrinsic Value of the OTM option price?
More...

You are missing the crucial point that delta does not change the price.
Delta reflects what the change in price will be for a change in the underlying.

example; if the underlying price does not change but the volatility changes then the option price will also change.
Hence why (and yes it can be confusing, and I would say wrong in this case) they say that the OTM component of an option price is determined by its vega.
It is more determined by its volatility as an input .....not the vega. Think of Vega as the output.
They are simply lumping in everything else together and calling it vega as the extrinsic value.
 
SIUYA said:
You are missing the crucial point that delta does not change the price.
Delta reflects what the change in price will be for a change in the underlying.

example; if the underlying price does not change but the volatility changes then the option price will also change.
Hence why (and yes it can be confusing, and I would say wrong in this case) they say that the OTM component of an option price is determined by its vega.
It is more determined by its volatility as an input .....not the vega. Think of Vega as the output.
They are simply lumping in everything else together and calling it vega as the extrinsic value.
More...

Yes, I know Delta does not change the price. As I said "Delta is a measure of the change in the options' price resulting from the change in the underlying stock price". So, the underlying stock price change, change the option price. Delta is the measure of the change.

Just like Vega does not change the price. Change in volatility change the price. So is Theta, etc.

So, let me rephrase my question: If OTM options only have Extrinsic Value, and Delta only affect the Intrinsic Value, then how is Delta affect the OTM options price?
 
tonylim said:
Yes, I know Delta does not change the price. As I said "Delta is a measure of the change in the options' price resulting from the change in the underlying stock price". So, the underlying stock price change, change the option price. Delta is the measure of the change.

Just like Vega does not change the price. Change in volatility change the price. So is Theta, etc.

So, let me rephrase my question: If OTM options only have Extrinsic Value, and Delta only affect the Intrinsic Value, then how is Delta affect the OTM options price?
More...

Delta doesn't only affect intrinsic value. You have a 5percrnt otm call. Stock rallies 5percent and vols stay the same. Should the option go up in price? What risk factor would describe that increase in price?
 
tonylim said:
Yes, I know Delta does not change the price. As I said "Delta is a measure of the change in the options' price resulting from the change in the underlying stock price". So, the underlying stock price change, change the option price. Delta is the measure of the change.

Just like Vega does not change the price. Change in volatility change the price. So is Theta, etc.

So, let me rephrase my question: If OTM options only have Extrinsic Value, and Delta only affect the Intrinsic Value, then how is Delta affect the OTM options price?
More...

your main question was -- " how is the Delta of OTM option affect option price?"

Are you sure 'affect' is the right word you wish to use?
 
Reread original post:

Answer is YES.

Options that are out of the money have delta.

The description you read regarding delta is wrong. It does not just apply to in the money options (though in the money options have more delta that out of the money options)
 
SIUYA said:
your main question was -- " how is the Delta of OTM option affect option price?"

Are you sure 'affect' is the right word you wish to use?
More...

ya, 'affect' might not be the right word. let me try again.

If "Delta is a measure of the change in the options' price resulting from the change in the underlying stock price", so is the measure of the change in Intrinsic Value or Extrinsic Value?
 
tonylim said:
ya, 'affect' might not be the right word. let me try again.

If "Delta is a measure of the change in the options' price resulting from the change in the underlying stock price", so is the measure of the change in Intrinsic Value or Extrinsic Value?
More...

Its a good question.....A: both.
The Delta is the change in the option price ....this is made up of 2 parts
If the underlying moves, then by implication the intrinsic part changes as well when ITM, as well as the extrinsic part.
However, if it is OTM, and intrinsic is 0 then it is entirely a change of the extrinsic.

I would not think of it in this divisive way, its best to understand that the option price is what it is - changed by the input paratmers - and then it can be further divided into 2 parts if ITM. The intrinsic part being a minimum or floor value.

Now - if the underlying does not move (no delta moves), then changes in the input parameters will change only the extrinsic values.
 
Consider Put Call parity.
OTM option is synthetically ITM.
Except for skew, the Bell curve should be symmetrical.

Carl
 
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