Understanding and mastering the Greeks are key factors in becoming an elite covered call writer and put-seller. In this article, I will focus on delta, one of the important Greeks, as it relates to the moneyness of options (in-the-money, at-the-money or out-of-the-money). Let’s start with a review of a few definitions:
Greeks: They are numbers generated by mathematical formulas resulting in ways of estimating the risks associated with options, such as the risk of the stock price moving up or down, implied volatility moving up or down, or how much money is made or lost as time passes.
Delta: The amount an option will change in value for every $1 change in share price. The greater the chance of the strike ending up in-the-money, the greater the delta. Delta values run from 0 to 1.
Moneyness of options: Describes the relationship between options strike price and the price of the underlying security and determines if intrinsic value exists in an option.
On page 164 of the Complete Encyclopedia for Covered Call Writing, Figure 70 shows the relationship between the moneyness of options and delta:
We can see that out-of-the-money strikes have deltas under .5, at-the-money strikes have deltas at about .5 and in-the-money strikes have deltas above .5. The deeper out-of-the-money the strike, the closer the delta is to 0 and the deeper in-the-money the strike, the closer deltas are to 1.
Delta and the BCI covered call writing 20/10% guidelines
The 20/10% guidelines are among the most important BCI principles relating to position management for covered call writing. It sets a guideline as to when to buy back an option (close the short option position) when the price of the underlying security drops in value. Since we generate more total premium (not necessarily more time value) for an in-the-money strike, the fact that the delta is higher than for an out-of-the-money strike, premium value will erode faster due to delta and allow us to close the short position in a timely manner should share value decline. The smaller total premiums generated from at-the-money and out-of-the-money options will erode slower also due to delta and therefore keep us from closing our positions too soon.
Why aren’t the deltas for exactly at-the-money strikes exactly .5?
This is more a point of interest rather than a concept that will influence our trading strategy. Generally a call option will have a delta slightly greater than .5 for an exactly at-the-money strike and a put option will have a delta slightly under .5 in that scenario. This relates to interest rates which make the call more valuable as option buyers can control shares of stock at a lower price and leverage the “saved” cash to earn interest. The greater the time until expiration, the greater the call delta will be in relationship to the put delta. Again, this is an interesting (perhaps not?) fact and I present it to you in case you get an options question on Jeopardy (even Alex wouldn’t know this one!).
The impact of delta, which erodes the value of pricier in-the-money strikes quicker than cheaper out-of-the-money strikes, is responsible for allowing the BCI 20/10% guidelines to have universal application for all strike prices.
***Puts show negative deltas because as share price rises, put values decline.
Next live seminar:
Monday May 18th…click for details.
7 Pm – 9 PM
I will be focusing on covered call writing but will also provide a segment on selling cash-secured puts.
Same day: Boulder, Colorado (just added)
Group- AAII Sub Group- contact
Frasier Meadows Retirement Community
350 Ponca Pl, Boulder, CO 80303
1:30 PM – 3 PM
New seminar just added:
Northern New Jersey
Tuesday October 13th, 2015
6:45 to 8:30 PM
Millburn Public Library
“The Basics of Covered Call Writing with a Brief Discussion of Put-Selling”
Negotiating commission rates
One of our members re-negotiated his Schwab online commission rates this week…
- $6.95 pet ticket
- $0.40 per contract
- $6.95, any number of shares
Weaker-than-expected first-quarter US growth caused global markets to decline but also making the Federal Reserve more likely to delay interest rate hikes beyond June. This week’s reports:
- US economic growth, as measured by gross domestic product (GDP), came in at only 0.2% at an annualized rate in the first quarter, below the consensus forecast of 1% and down from 2.2% in the fourth quarter
- Consumer spending rose 1.9%, slightly better than expected despite harsh weather
- The trade deficit cut 1.25 percentage points from the GDP growth rate as the strong US dollar hurt exports
- Initial claims for US unemployment benefits fell 34,000 to 262,000 for the week ended 25 April, the lowest level since April 2000
- Continuing claims decreased 74,000 to 2.25 million for the week ended 18 April
- The Conference Board’s index of consumer confidence fell to 95.2 in April from 101.4 in March
- The University of Michigan’s consumer sentiment index rose to 95.9 from 93.0 over the same period
- US consumer spending rose 0.4% in March after a 0.2% increase in February
- Spending adjusted for inflation was up 0.3% in March
- The US employment cost index rose a seasonally adjusted annualized 0.7% in the first quarter
- Wage and benefit costs rose 2.6% annually, up from 2.2% year over year in the second half of 2014
- The preliminary service sector PMI (an indicator of the economic health of the manufacturing sector) fell to 57.8 in April from 59.2 in March, while the final manufacturing PMI slipped to 54.1 from 55.7, the slowest pace of growth this year.
- The S&P/Case-Shiller index of national home prices rose 4.2% for the year ended in February. The index of home prices in 20 cities climbed 5%
For the week, the S&P 500 declined by 0.6%% for a year to date return of 2.2%.
IBD: Uptrend under pressure
GMI: 3/6- Buy signal since market close of January 23, 2015
BCI: Cautiously bullish and using an equal number of in-the-money and out-of-the money strikes. The triple digit moves in the market are a bit unsettling and keeping this conservative investor from taking a more aggressive stance.
Wishing you the best in investing,