11.delta (Part 3) - Zerodha Varsity

9/5/2015
Delta(Part3)ZerodhaVarsity
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CHAPTER 11
Delta (Part 3)
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11.1 Add up the Deltas

Here is an interesting characteristic of the Delta The Deltas can be added up!
Let me explain we will go back to the Futures contract for a moment. We know for every point
change in the underlyings spot value the futures also changes by 1 point. For example if Nifty
Spot moves from 8340 to 8350 then the Nifty Futures will also move from 8347 to 8357 (i.e.
assuming Nifty Futures is trading at 8347 when the spot is at 8340). If we were to assign a delta
value to Futures, clearly the futures delta would be 1 as we know for every 1 point change in the
underlying the futures also changes by 1 point.
Now, assume I buy 1 ATM option which has a delta of 0.5, then we know that for every 1 point
move in the underlying the option moves by 0.5 points. In other words owning 1 ATM option is as
good as holding half futures contract. Given this, if I hold 2 such ATM contracts, then it as good as
http://zerodha.com/varsity/chapter/deltapart3/
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holding 1 futures contract because the delta of the 2 ATM options i.e. 0.5 and 0.5, which adds up
to total delta of 1! In other words the deltas of two or more option contracts can be added to
evaluate the total delta of the position.
Let us take up a few case studies to understand this better
Case 1 Nifty spot at 8125, trader has 3 different Call option.
Sl
No
Contract
Classification
Lots
Delta
Position Delta
8000 CE
ITM
1 -Buy
0.7
+ 1 * 0.7 = + 0.7
8120 CE
ATM
1 -Buy
0.5
+ 1 * 0.5 = + 0.5
8300 CE
Deep OTM
1- Buy
0.05
+ 1 * 0.05 = + 0.05
= 0.7 + 0.5 + 0.05 = +
1.25
Total Delta of positions

Observations
1. The positive sign next to 1 (in the Position Delta column) indicates Long position
2. The combined positions have a positive delta i.e. +1.25. This means both the underlying
and the combined position moves in the same direction
3. For every 1 point change in Nifty, the combined position changes by 1.25 points
4. If Nifty moves by 50 points, the combined position is expected to move by 50 * 1.25 = 62.5
points
Case 2 Nifty spot at 8125, trader has a combination of both Call and Put options.
Sl
No
Contract
Classification
Lots
Delta
Position Delta
8000 CE
ITM
1- Buy
0.7
+ 1*0.7 =0.7
8300 PE
Deep ITM
1- Buy
1.0
+ 1*-1.0 = -1.0
8120 CE
ATM
1- Buy
0.5
+ 1*0.5 = 0.5
8300 CE
Deep OTM
1- Buy
0.05
+ 1*0.05 = 0.05
0.7 1.0 + 0.5 + 0.05 =

+ 0.25
Observations
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1. The combined positions have a positive delta i.e. +0.25. This means both the underlying
and the combined position move in the same direction
2. With the addition of Deep ITM PE, the overall position delta has reduced, this means the
combined position is less sensitive to the directional movement of the market
4. If Nifty moves by 50 points, the combined position is expected to move by 50 * 0.25 = 12.5
points
5. Important point to note here Deltas of the call and puts can be added as long as it
belongs to the same underlying.
Case 3 Nifty spot at 8125, trader has a combination of both Call and Put options. He has 2
lots Put option here.
Sl
No
Contract
Classification
Lots
Delta
Position Delta
8000 CE
ITM
1- Buy
0.7
+ 1 * 0.7 = + 0.7
8300 PE
Deep ITM
2- Buy
-1
+ 2 * (-1.0) = -2.0
8120 CE
ATM
1- Buy
0.5
+ 1 * 0.5 = + 0.5
8300 CE
Deep OTM
1- Buy
0.05
+ 1 * 0.05 = + 0.05
0.7 2 + 0.5 + 0.05 =
0.75

Observations
1. The combined positions have a negative delta. This means the underlying and the
combined option position move in the opposite direction
2. With an addition of 2 Deep ITM PE, the overall position has turned delta negative, this
means the combined position is less sensitive to the directional movement of the market
4. If Nifty moves by 50 points, the position is expected to move by 50 * (- 0.75) = -37.5 points
Case 4 Nifty spot at 8125, the trader has Calls and Puts of the same strike, same
underlying.
Sl No
Contract
Classification
Lots
Delta
Position Delta
8100 CE
ATM
1- Buy
0.5
+ 1 * 0.5 = + 0.5
8100 PE
ATM
1- Buy
-0.5
+ 1 * (-0.5) = -0.5
+ 0.5 0.5 = 0
Observations
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1. The 8100 CE (ATM) has a positive delta of + 0.5

2. The 8100 PE (ATM) has a negative delta of 0.5
3. The combined position has a delta of 0, which implies that the combined position does
not get impacted by any change in the underlying
a. For example If Nifty moves by 100 points, the change in the options positions
will be 100 * 0 = 0
4. Positions such as this which have a combined delta of 0 are also called Delta Neutral
positions
5. Delta Neutral positions do not get impacted by any directional change. They behave as if
they are insulated to the market movements
6. However Delta neutral positions react to other variables like Volatility and Time. We will
discuss this at a later stage.
Case 5 Nifty spot at 8125, trader has sold a Call Option
Sl No
Contract
Classification
Lots
Delta
Position Delta
8100 CE
ATM
1- Sell
0.5
1 * 0.5 = 0.5
8100 PE
ATM
1- Buy
-0.5
+ 1 * (-0.5) = 0.5
0.5 0.5 = 1.0
Observations
1. The negative sign next to 1 (in the Position Delta column) indicates short position
2. As we can see a short call option gives rise to a negative delta this means the option
position and the underlying move in the opposite direction. This is quite intuitive
considering the fact that the increase in spot value results in a loss to the call option seller
3. Likewise if you short a PUT option the delta turns positive
a. -1 * (-0.5) = +0.5
Lastly just consider a case wherein the trader has 5 lots long deep ITM option. We know the total
delta of such position would + 5 * + 1 = + 5. This means for every 1 point change in the underlying
the combined position would change by 5 points in the same direction.
Do note the same can be achieved by shorting 5 deep ITM PUT options
5*1=+5
-5 indicate 5 short positions and -1 is the delta of deep ITM Put options.
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The above case study discussions should give you a perspective on how to add up the deltas of
the individual positions and figure out the overall delta of the positions. This technique of adding
up the deltas is very helpful when you have multiple option positions running simultaneously and
you want to identify the overall directional impact on the positions.
In fact I would strongly recommend you always add the deltas of individual position to get a
perspective this helps you understand the sensitivity and leverage of your overall position.
Also, here is another important point you need to remember
Delta of ATM option = 0.5
If you have 2 ATM options = delta of the position is 1
So, for every point change in the underlying the overall position also changes by 1 point (as the
delta is 1). This means the option mimics the movement of a Futures contract. However, do
remember these two options should not be considered as a surrogate for a futures contract.
Remember the Futures contract is only affected by the direction of the market, however the
options contracts are affected by many other variables besides the direction of the markets.
There could be times when you would want to substitute the options contract instead of futures
(mainly from the margins perspective) but whenever you do so be completely aware of its
implications, more on this topic as we proceed.
11.2 Delta as a probability

Before we wrap up our discussion on Delta, here is another interesting application of Delta. You
can use the Delta to gauge the probability of the option contract to expire in the money.
Let me explain when a trader buys an option (irrespective of Calls or Puts), what is that he
aspires? For example what do you expect when you buy Nifty 8000 PE when the spot is trading at
8100? (Note 8000 PE is an OTM option here). Clearly we expect the market to fall so that the Put
option starts to make money for us.
In fact the trader hopes the spot price falls below the strike price so that the option transitions
from an OTM option to ITM option and in the process the premium goes higher and the trader
makes money.
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The trader can use the delta of an option to figure out the probability of the option to transition
from OTM to ITM.
In the example 8000 PE is slightly OTM option; hence its delta must be below 0.5, let us fix it to 0.3
for the sake of this discussion.
Now to figure out the probability of the option to transition from OTM to ITM, simply convert the
delta to a percentage number.
When converted to percentage terms, delta of 0.3 is 30%. Hence there is only 30% chance for the
8000 PE to transition into an ITM option.
Interesting right? Now think about this situation although an arbitrary situation, this in fact is a
very real life market situation
1. 8400 CE is trading at Rs.4/2. Spot is trading at 8275
3. There are two day left for expiry would you buy this option?
Well, a typical trader would think that this is a low cost trade, after all the premium is just Rs.4/hence there is nothing much to lose. In fact the trader could even convince himself thinking that if
the trade works in his favor, he stands a chance to make a huge profit.
Fair enough, in fact this is how options work. But lets put on our Model Thinking hat and figure
out if this makes sense
1.
2.
3.
4.
8400 CE is deep OTM call option considering spot is at 8275

The delta of this option could be around 0.1
Delta suggests that there is only 10% chance for the option to expire ITM
Add to this the fact that there are only 2 more days to expiry the case against buying this
option becomes stronger!
A prudent trader would never buy this option. However dont you think it makes perfect sense to
sell this option and pocket the premium? Think about it there is just 10% chance for the option
to expire ITM or in other words there is 90% chance for the option to expire as an OTM option.
With such a huge probability favoring the seller, one should go ahead and take the trade with
conviction!
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In the same line what would be the delta of an ITM option? Close to 1 right? So this means there
is a very high probability for an already ITM option to expire as ITM. In other words the probability
of an ITM option expiring OTM is very low, so beware while shorting/writing ITM options as the
odds are already against you!
Remember smart trading is all about taking trades wherein the odds favor you, and to know if the
odds favor you, you certainly need to know your numbers and don your Model Thinking hat.
And with this I hope you have developed a fair understanding on the very first Option Greek The
delta.
The Gamma beckons us now.
Key takeaways from this chapter

1.
2.
3.
4.
5.
The delta is additive in nature

The delta of a futures contract is always 1
Two ATM option is equivalent to owning 1 futures contract
The options contract is not really a surrogate for the futures contract
The delta of an option is also the probability for the option to expire ITM
(http://zerodha.com/varsity/chapter/delta-part-2/)
(http://zerodha.com/varsity/chapter/gamma-part-1/)
36 Responses to Delta (Part 3)

Reply (http://zerodha.com/varsity/chapter/delta-part-3/?replytocom=14703#respond)
KHYATI VERDHAN
7/17
9/5/2015
KHYATI VERDHAN
June 15, 2015 at 10:57 am
Hi kartik
Very very thanks for this chapter.This is very intresting chapter, but after reading this a no. of things running in my mind. Please
check this and correct me where I am wrong.
If delta (sum of all deltas) is
1. +1.75
Profit- when market goes up
Loss when market goes down
2. +.025
Profit- when market goes up
Loss when market goes down
3. 0
No profit , No loss at any market movement
4. -.075
Profit- when market goes down
Loss when market goes up
I also think to calculate net p&l , I can do it mathematicallyNet P&L= total no. of shares of same underlying * change in underlying *total delta(sum of all deltas)
Profit- when market goes up and delta is +ve
Or
When market goes down and delta is ve
LOSS- when market goes up and delta is -ve
Or
When market goes down and delta is +ve
Is this formula correct??? Since delta is also variable , I am confused. Please clarify
(http://zerodha.com/varsity/comment/14703)
KARTHIK RANGAPPA
June 16, 2015 at 4:46 am
You are absolutely right here

1) If the deltas add up to a +ve number, this means you make money when the markets goes up
2) If the deltas add up to a -ve number, this means you make money when the markets goes down
3) Net P&L = Change in underlying * Total Delta * Lot size -> how ever please do bear in mind this is only an expected
P&L and not really the actual P&L. Remember an options contract is subjected to other variableswe will understand
this point in detail over the subsequent chapters.
8/17
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Reply
NARSIMHA
June 15, 2015 at 12:23 pm
sir,in tradinr intraday or swing what is definition of down &uptrenr i mean how many candeles down,up
(http://zerodha.com/varsity/chapter/delta-part-3/?replytocom=14704#respond)
Reply (http://zerodha.com/varsity/chapter/delta-part-3/?
KARTHIK RANGAPPA
June 16, 2015 at 4:48 am
replytocom=14735#respond)
Check for at least 6 to 8 prior candles.

JAGADEESH (HTTP://WWW.DISCRETIONARY-TRADING.COM)
June 15, 2015 at 3:45 pm
Yet another great article.. Thanks for this..

Reply
KARTHIK RANGAPPA
June 16, 2015 at 4:49 am
I must thank you for patiently reading all the articles on Varsity and constantly encouraging us
KIERON
June 15, 2015 at 7:36 pm
Thank you sir salute you for an great article

Reply
KARTHIK RANGAPPA
June 16, 2015 at 4:56 am
Most welcome and I really hope you found the chapter useful and easy to understand.
9/17
9/5/2015
KAVYASALUNKE
June 16, 2015 at 7:05 pm
sir i have doubt regarding stoploss of option order,if i want to place stop loss for option with repect to its underlying how can i
calculate it? also if option expiring as otm but if my premium is changed by 4-5 what should i consider it means profit or I had
paid premium after profit?
KARTHIK RANGAPPA
June 17, 2015 at 5:33 am
This is a very valid question in fact I would explain this in detail when we take up the 3rd option Greek Vega. So
request you to please stay tuned till then. Thanks.
KHYATI VERDHAN
June 17, 2015 at 7:31 am
Hi kartik,
Thanks for clearing my confusions.I have read the chapter many times and develops a clear concept. Clearly, options are
superior than futures. But, thinks problems me is- if X persons trade nifty futures, he has to trade at nifty future prices but if Y
persons trade nifty options and there are 10 strike prices available , then each strike price has only Y/10 volume. However, ATM
options are somehow more volume. Then is there any volume issue with options. Please clarify.
KARTHIK RANGAPPA
June 18, 2015 at 5:29 am
I get your point here, in fact for this reason along with many others ATM options are always a good option to trade. You
will understand more on this as we progress.
10/17
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Reply (http://zerodha.com/varsity/chapter/delta-
ADITYA GARG
July 14, 2015 at 6:29 am
part-3/?replytocom=15964#respond)
hi sir thanks for such a simplified version of greeks.

when we can expect article on option strategy?
Reply
KARTHIK RANGAPPA
July 15, 2015 at 5:21 am
Aditya, all I can say at this point is soon
(http://zerodha.com/varsity/chapter/deltapart-3/?replytocom=16001#respond)
Reply
KESHAV
June 17, 2015 at 1:34 pm
I am eagerly waiting for option strategies.. When will u complete this module..?
When will u upload next chapter..?
KARTHIK RANGAPPA
June 18, 2015 at 5:33 am
Chapter 12 about Gamma (Part 1) should be up by trow it is a very different chapter and hopefully you will enjoy
reading it
ALOK
June 17, 2015 at 1:51 pm
Worth itNice job i appreciate your efforts.

11/17
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KARTHIK RANGAPPA
June 18, 2015 at 5:34 am
Thanks Alok
ARSHAD
June 17, 2015 at 9:41 pm
I have spent lots of money for getting training about but all are worthless as compare to Varsity.u all did a great job..thanks..
KARTHIK RANGAPPA
June 18, 2015 at 5:38 am
Thanks Arshad.
There are many so called market educators who in the pretext on teaching market finance fleece your hard earned
money. Keeping this in perspective we started Varsity with an objective of creating an online platform where we put up
meaningful content and make it available for everyone, for free.
AJAY
June 20, 2015 at 3:12 pm
Hello.
I recently read about the Adani enterprise demerger and the controversy surrounding it s the stock plunged 80% intraday. How
does it impact the a) market lot b) futures price c) premium?
KARTHIK RANGAPPA
12/17
9/5/2015
KARTHIK RANGAPPA
June 22, 2015 at 5:07 am
Adani was a mess mostly attributable to people not reading the circular issued by NSE. The lot size/Future
Price/Premium all depends on the corporate action in perspective. However they all reduce or increase in proportion
to the spot value.
RAMESH
July 8, 2015 at 8:20 am
Hi Team,
Great articles/modules. Ive learnt a lot here than reading/attending classes. Very well writen with lots of examples. Thank you
very much.
A lay man question: In delta lesson modul, youd mentioned that +5 delta moves by 5 points the underling movement of 1
point. Are you refering to points as in premium change? Pleae kindly clarify.
KARTHIK RANGAPPA
July 10, 2015 at 4:42 am
Thanks Ramesh, very happy to know that you appreciate the efforts. Please do stay tuned for more.
Yes, if an option has a Delta of 0.5, then for every 1 point change in the underlying then the premium changes by 0.5
points.
RAMESH
July 16, 2015 at 6:22 am
Thank You Karthik.

So if 5 contracts of 0.5 Delta then, the Delta adds up to 2.5. Then every 1 point move in underlying the position
will now move 2.5 times (premium points) either side up or down.
13/17
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Reply
KARTHIK RANGAPPA
July 16, 2015 at 7:09 am
Yes sir. Thats correct.
SANATHARAM
July 8, 2015 at 6:41 pm
Can I use option strategies for intraday trading depending upon the situation? In intraday for example if am using bull spread,
the shorted OTM Option wont have much impact due to non deterioration of theta.. Even the Usage of neutral strategy,
shorting 2ATM, Buying 1ITM & 1OTM wont have much impact if my position is wrong.. Suggest the usage of options strategy for
intraday trading
KARTHIK RANGAPPA
July 10, 2015 at 4:56 am
SanatharamI will be discussing options strategies in detail in the next module. Request you to kindly stay tuned.
SUSANTA
August 9, 2015 at 5:06 am
Hi, thanks for the all teaching modules.. I understand that Delta for call option is +ve, and delta for Put option is -ve. I have a
question.. Can delta be a negative value for a only call option ? I assume not.. But still have a confusion.
KARTHIK RANGAPPA
August 10, 2015 at 6:40 am
14/17
9/5/2015
Call Delta per say is a +ve number, but when you short a call option the Delta is considered -ve. Similarly when you
short a put option the delta is considered +ve.
ANAND SINGH
August 26, 2015 at 7:20 am
Hi Karthik, I didnt understand the case no #5 in this chapter. Can you please elaborate this with premium, delta values for
better understanding. Thanks in advance
KARTHIK RANGAPPA
August 27, 2015 at 5:32 am
Anand Case 5 talks about a situation wherein you have a short ITM Call option. ITM options have a delta of 0.5, since
you are short call option the position delta would be 1 * (-0.5) = -0.5. The other position is a long ITM Put option. Put
option has a negative deltabut do remember when you short a put option, the delta is +ve.
So the overall delta of this position becomes -0.5 (from short ITM call) plus -0.5 (from long ITM Put), hence an over all
delta of -1.0.
Reply (http://zerodha.com/varsity/chapter/delta-part-
ANAND SINGH
August 27, 2015 at 7:20 am
3/?replytocom=18145#respond)
Sir, It is ATM position as delta is 0.5. Correct Sir.

Reply
KARTHIK RANGAPPA
August 28, 2015 at 5:33 am
Yup.in and around 0.5.
15/17
9/5/2015
ANAND SINGH
August 28, 2015 at 8:44 am
Thanks Karthik. I owe you a lot. Your gyan on technical analysis enriched my knowledge and
ignited passion for trading. Thanks a ton. After saying goodbye to long career in banking and
insurance I decided to become full time trader and was looking for authentic material on TA
and FA. Believe me your content is far more better than any book on share market in
circulation. Karthik tell me is it true that 95% people loose money in the market. If it is true
then who are the rest 5%. And how to increase the success rate in trading. Plz share your
thoughts.
KARTHIK RANGAPPA
August 29, 2015 at 6:30 am
Thanks for the kind words Anand. Yes, it is true that most of the people lose money
attempting to trade. Think is mainly because the vast majority trade based on gut feel, and
random theories. Besides somewhere their egos take over their brains and they fail to evolve
themselves as traders. Most of them dont even bother to educate themselves.
My suggestion Stay humble and constantly educate yourself. This alone will enhance your
odds of being successful in the markets.
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Copyright 2014 Varsity@Zerodha
Chapter 11
Option Theory
(http://zerodha.com/varsity)
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9/5/2015

11.1 Add up the Deltas

Total Delta of positions

Total Delta of positions

0.7 1.0 + 0.5 + 0.05 =

Total Delta of positions

Total Delta of positions

1. The 8100 CE (ATM) has a positive delta of + 0.5

Total Delta of positions

0.5 0.5 = 1.0

11.2 Delta as a probability

8400 CE is deep OTM call option considering spot is at 8275

Key takeaways from this chapter

The delta is additive in nature

36 Responses to Delta (Part 3)

You are absolutely right here

Check for at least 6 to 8 prior candles.

Yet another great article.. Thanks for this..

Thank you sir salute you for an great article

hi sir thanks for such a simplified version of greeks.

Aditya, all I can say at this point is soon

Worth itNice job i appreciate your efforts.

Thank You Karthik.

Yes sir. Thats correct.

Sir, It is ATM position as delta is 0.5. Correct Sir.

Yup.in and around 0.5.

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