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Options Theory: Delta, the Great Equalizer

September 29, 2018

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I love the options greeks for many reasons. One will be on full display today. Delta is a multi-faceted metric used by traders a variety of ways. Perhaps one of my favorites is to use it as an equalizer.

Allow me to explain, starting with a brief vocabulary review.

Options Theory: Delta, the Great Equalizer

Bullish positions are positive delta, and bearish positions are negative delta. On an elementary level, there are six fundamental ways to express a directional opinion. Three are bullish, and three are bearish.

  • Positive Delta: Long stock, long calls, short puts
  • Negative Delta: Short stock, long puts, short calls

Viewed through the lens of delta, there isn’t a difference between buying AAPL stock, buying AAPL calls, or selling AAPL puts. For example, buying 50 shares of stock carries the same directional exposure as purchasing a 50 delta call or shorting a 50 delta put. They are, from a directional standpoint, equal.

This is the beauty of plotting delta as a column in your position statement. You get to distill every single position into a single number which represents the level of exposure. Easy. Simple. Clean.

Now, another area where this helps is understanding the similarities between positions. If I’m bearish on Alibaba (BABA) stock, I have a dozen different ways I can express my opinion such as:

  • Short 50 shares of stock
  • Buy an ATM -50 delta put
  • Sell two OTM 25 delta calls
  • Buy two -25 delta put vertical spreads
  • Buy four -12.50 delta put diagonal spreads

Ultimately, all of these have the same degree of directional exposure. Over the next dollar rise or fall, I will experience a $50 fluctuation in my position. Which strategy I choose, then, comes down to a few different factors. But the one that I will argue is the most important is this: select the strategy you have the most confidence in your ability to trade profitably over time. And since profitability is a byproduct of trade management, we could say that the strategy you’re most confident in managing should be your go-to.

I’m thinking primarily about how to deal with trades gone wrong. Personally, I find it easiest to handle short calls. Thus, they are my favorite way of expressing a bearish opinion. I suspect, if pressed, I could apply some of my time-tested tactics for wrangling a losing short call position to other strategies mentioned above, but I’m not convinced it would be worth the extra effort. For now, I’m content in relying on the adage, “if it ain’t broke, don’t fix it,” and sticking with my bread and butter.

Short calls, and their defined risk counterpart bear calls, have a lot going for them. First is the wide profit range that allows for plenty of wandering by the underlying. Second is the inherent overpricing of options. The third is the benefit of time decay. Fourth is the ease with which I can scale in to improve my odds. Fifth is the can-kicking that’s available via rolling out if things get nasty and I need to extend the duration to see if more time will bail me out.

Anyways, this started out as a pitch for why delta is one of my best buddies and turned out to be a lovefest for short calls. My objective (and hopefully I achieved it), was to show how when you truly understand delta you begin to look at the myriad of bearish strategies as simple variations of a theme. Short delta is short delta, and I don’t much care how you get it when you’re bearish. As long as you’re confident in your management abilities, then swing away with whatever strategy you like.

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