Of course you want to know how “big” your option position is. After all, you’re looking to make a profit on your trades, right? However, how do you know just how “big” it actually is?
A trader who owns 10 calls controls 1,000 shares of stock. If exercised, those 10 calls turn into long 1,000 shares at the strike price. From this point, the trader will make or lose $1,000 for each dollar change in the stock price.
However, most traders are not concerned about what their positions might be down the road. They want to know how “big” their positions are right now.
If you trade options from the long side, think about using the following shortcut to help you understand how “big” your option position is in real time.
The delta of an option tells you how sensitive that option’s price is to a $1 change in the price of the underlying security. It is an immediate measure. If you own a call option, you have positive delta– an increasing stock price wants to drive the call price higher. If you own a put option, you have negative delta – a declining stock price wants to push the put price higher.
For example, you own 10 calls with a delta of .60. If the stock increases in price by $1, the option’s price is expected to increase by $0.60 (all other things being equal). This comes out to $60 per option (100 shares per option). Your 10 option position increases by $600 (you’ll lose $600 if the stock declines by $1).
Question: How many shares of stock must you own to experience an increase value of $600 if the stock increases by $1?
Answer: 600 shares.
This is very valuable information – it tells you that, right now, your long 10 calls is going to behave like 600 shares.
How to Calculate How Big Your Option Position Really is Right Now
Here’s a formula for you to use:
(Number of options you own X the option’s delta) X 100
The total delta of your option position tells you how many shares of stock the option position is expected to behave like! (A little-used definition of delta is share equivalents) Some trading platforms provide this information with descriptions like total delta or dollar delta.
You can use this concept in conjunction with other options pricing concepts to help you determine how many options to buy when you establish a position and develop a position management plan.
Two important considerations:
- Options eventually expire – make sure you understand the implications of time on your trade
- If you are short an option that is assigned, it immediately converts to 100 shares. Your position immediately converts to short 100 delta per call option or long 100 delta per put option.
If you do try this out, let me know how it goes.