Quote from optioncoach:
To finish off on what I was saying on DELTAs:
ITM - higher cost but higher sensitivity to movement in the underlying price. Higher probability of option staying ITM so this shoudl balance out higher cost.
If we do ITM spreads such as bull call spreads, we negate deltas and gammas to an extent since we are short and long an option and the sensitivity is not coming from delta so much as it is coming from time decay for the most part (depending on how much time to exp is really left).
OTM - tiny deltas and gammas and initially not very sensitive to movement in the underlying. However being on the tail of the gamma curve, the sensitivity can increase rather fast if a significant move in the underlying occurs. Great if you are long deltas, shitty if you are short deltas.
ATM - sort of your best balance of deltas and gammas are at their peak. Cost is less than ITM options but slightly less sensitivity, cost is more than OTM and slightly more sensitivity. Better prob. than OTM and less than ITM.
THis is the delta/gamma balance and we use this understanding each and every time we choose to select a position, strikes and use it to compare spreads v. single option positions as well as to better understand complex option positions.
Your goal starting now is before each and every position you put on is to calculate or find the position delta, or net delta if it is a spread, and understand in general what is the sensitivity of your position. ToS analyzer makes it easy to do this as well as the position monitor page.
Alwas ask yourself are you long or short delta, which also tells you if you are long or short gamma, and then determine where on the gamma curve are you? Are you near the peaks sliding down or are you at the tails buying or selling "cheap" gamma.
Remember that calls have +delta and puts have - delta. Same strike deltas should add up to zero for calls and puts. So any straddle will have a net delta of 0 initially- thus the moniker "delta-neutral" What makes it move from delta neutral to a delta bias? Gamma in each option changing the deltas so the addition of the call and put deltas no longer equals 0.00 but a positive or negative number based on movement in the underlying.
Here are some questions to "test" your understanding:
1. Pick any stock (not an index for now) and look at the ATM, ITM, and OTM deltas in the option chain for a given month. Taking turns plug in a random ITM, ATM and OTM call into the ToS analyzer and using day step +4 over a few days each step see how the call reacts to movement in the underlying. SEE the sensitivities. If you were to buy a call on this stock and had an expectation it would go higher, make an assumption of how much higher you think it would go and see which options offer you personally the best risk/reward trade off that suits your style. If you are stuck, take GOOG at 546 and compare the 545, 514 and 575 strikes for either AUG or SEP whichever is traded (skip JUL right now as we do nto want to introduce time concepts yet). Assume you expected GOOG to hit 575 in a month or so, which option reacts best in your opinion (this is not a trick question, there is no right answer, only the best answer for your own risk tolerance so dont look for a specific answer, pick the one you like best).
2. Now put a 545 SEP (if traded) straddle in the analyzer for GOOG and notice over a few days how the position does if GOOG moves up or down. Not much given the delta neutrality and the fact that both options have high gamma. In other words if stock goes up, call gains and deltas change by gamma but put loses and deltas change by gammas and they usually offset each other for the most part. Therefore it shows WHY the straddle needs a lot of movement to profit. It has to overvcome the deltas and gammas offsetting each other from the calls and puts until one side starts winning and the position develops a delta bias in one direction.
I think doing this will get you familair with ToS analyzer and bring home the point of SENSITIVITY of options.
