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INVESTORS in the derivatives market are familiar with the word `delta'. The delta measures the sensitivity of the option's price with respect to a small change in the price of the underlying.

For a futures position, the value of delta is usually one, while in case of options it keeps changing. The value of delta for a future contract is one, as any change in the underlying instrument will get reflected fully in the futures price also. Whereas in the case of an option instrument, say with a delta of 0.6, it means that for a Re 1 change in the price of the underlying, the price of option will change by Rs 0.60. An increase of Re 1 will lead to an increase in the option price by Rs 0.60 while a decline of Re 1 will lead to a decrease of Rs. 0.60. Clearly, if you are trading in options, delta is an important number for managing your exposure to underlying asset price risk.

Delta values normally vary between +1 and - 1. A long call option will have a delta between 0 and +1 while a long put option will have a delta of 0 and - 1. Obviously the delta of an option writer will be the obverse of the option buyer. Hence a call writer will have delta between 0 and - 1 and a put writer between 0 and +1. The delta of a position can be estimated using the Black Scholes model of option pricing.

However it may not be always possible to have the options calculator with the investor. Is there a rule of thumb, which gives an approximate value of the deltas to the investor?

The problem is that the delta movement is not linear and the delta itself keeps changing depending on the movement of the underlying security. Hence as the price of the security moves in the cash market, the delta also keeps changing depending on the direction of movement. How to keep track of this movement?

As a basic rule, an At the Money (ATM) option will have a delta of 0.50. The following table gives the likely values of deltas depending on the movement of the underlying security

The above values are only an approximation; the delta of a stock depends on other factors like volatility and time to expiry. As the time to expiry increases, the delta also increases.

The above table can be best understood with an example. Consider a call options on Satyam Computers. The current market price is Rs 177 and hence an option with a strike price of Rs 175 will be ATM. This option will have a delta of 0.50. However, when the stock price increases to Rs 180, then the option price will not increase by Rs 2.50 (0.50*5) as the delta itself has changed. As the stock price of Satyam goes one level in-the-money to Rs 180, the delta will increase to 0.60 and hence the value of option would have increased by Rs 3 (0.60*5). An increase of two levels in the money to a price of Rs 185 will increase the option delta to 0.70 and correspondingly change the value of the option instrument by Rs 7.

Similar is the case when the stock price falls. When the price falls from Rs 175 to Rs 170, the delta of the instrument will decline to 0.4 and hence the option price will decline by Rs 2.

Note: That this is only an approximation and gives an idea to the investor on the likely movement of the option price.

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