First of all thank you for your excellent responses to my questions.
I am learning about options and I have a question on the meaning of delta....
The official definiton seems to be that delta is the amount an option price changes for every dollar change in the underlying. There also seems to be an unofficial statement
(not sure where i got this from) that delta represents the likelihood that an option will finish in the the money.
It's this 2nd definition that intrigues me. Can you tell me if it has a basis in reality? If it is true then if I
consistently sell covered calls with a delta of 20% then I should expect to be assigned 20% of the time.
Also do you have any thoughts on delta based on historical volatility versus implied volatility? Should I pay attention to one more than the other?
Thanks for your time.
You are welcome. Thanks for the kind words.
1) Delta is as you describe it. But let me add that delta is not constant. As the stock price changes, delta changes. Gamma describes the rate at which delta changes. Delta also changes as time passes.
2) Delta also gives a very good approximation of the probability that the option will finish in the money. Just be certain you recognize that sometimes the option goes into the money, and then declines so that it's out of the money at expiration. In that scenario, what counts is that the option finished OTM.
3) Yes, if you sell 20 delta options, you should expect to be assigned about one time in five. (Do you really sell options with such low delta? That's a very bullish strategy.)
4) It's important to recognize that delta is dependent on the volatility of the options. Thus, it does make a difference whether you use historical or implied. There is much debate over which is better. As a long-term investor, there is a great deal to be said for using a historical volatility - especially when you want to estimate the probability of being assigned an exercise notice. On the other hand, the implied volatility represent the best current estimate for the future volatility of the stock, so many people prefer to use that number. My suggestion is to be consistent, but I really cannot tell you which to choose.
5) Does it really matter to you what the probability of being assigned is? Is being assigned a bad thing in your opinion (I love being assigned)? Are you writing covered calls to provide additional income, or are you also using them to provide a reasonable amount of insurance against a market decline? I don't have the answers that suit you - I'm raising these questions to be certain you know why you are writing covered calls. After all, you want the strategy to help you meet your investment objectives, so you must know what they are.
Mark D. Wolfinger
The Rookie's Guide to Options:
The Beginner's Handbook of Trading Equity Options