The Puzzle of Deltas

For years I have been telling traders to strive to purchase in-the-money options that have high Deltas, preferably 1, if possible.  Recently, Bev, a friend and fellow trader, and I had a discussion about Deltas, and she explained that she understood it to be advantageous to have a high Delta, but not necessarily as high as 1.  My goal has always been to achieve dollar option profit for every dollar stock profit.

Well, Bev gave me the particulars in a way that I could really understand, and I stand corrected.

So here are the details. 

Let’s take two different strike prices for the same option.
Ford Underlying is $13.73 (at time of Buy)
1. The 1.0 Delta,  premium is $5.80
When the stock moves to $14.73 (1 dollar gain),
the premium moves to $6.80  (1 dollar gain.)
If you divide 5.80 by 6.80, you get a 17% gain.
2.  The .71 Delta premium is $1.16
When the stock moves to $14.73 (1 dollar gain)
the premium moves to $1.87  (1.16 plus .71 cents)
If you divide 1.16 by 1.87, you get a 62% gain.
The cheaper the premium, the lower the Delta, but out-of-the-money gets very risky (as far as winning), but the rewards get higher as the delta gets lower. You’d just have to luck out. I still suggest buying at-the-money or in-the-money by a two levels with Delta between .55 and .80. these will have likelier wins.
Now admittedly, the difference in this shared example seems out of proportion. .71 Delta with premium of $ 1.16 and 1. Delta with a premium of $5.80. Big span between $5.80 and $1.16 and little span between 1. and .71.  But they’ve been used to illustrate the math involved.  As you now look at the option chains, trying to determine which of the in-the-money options holds the best percentage, you now have the knowledge and skills to answer the question for yourself. I thank Bev for bringing this advantage to my attention, and I am happy to share it with you.

Pay Attention To Where A Candle Closes

If a picture is worth a thousand words, the same can be said for a stock chart. Knowing how to read a candle chart can tell you a lot about how a stock trades.

Strip out all the indicators and moving average lines, relative strength lines and volume bars and you’re left with price action. That’s the most basic , and probably most important feature. On a stock’s price candle, which gives the daily or weekly price range, locate the hash mark or top and bottom of the candle’s body.

This short horizontal lines shows where the stock closed for the day or the week. In the case of the candle body, the top shadow shows the high of the day and the lower shadow line shows the low of the day.

Why should you pay attention to where the stock closes for the day?

It can help you gauge whether higher volume buyers are lending support to the stock. It’s a good sign if a stock keeps closing in the upper half of its daily or weekly price range. That means the big boys are likely snapping up shares, prompting the stock to rise or at least hold firm.

But a stock that often closes near its session lows signals weak demand for shares. Could mean the big boys are heading for the exits.

Hash marks or high candle body closes become even more important while a stock forms a base pattern. You’d want to see a stock close in the upper half of its weekly range at the bottom of a base or as it is building a support level.

A bullish reversal at the bottom of a base or support level is also a positive sign. This occurs when a stock declines sharply but ends up recouping most, if not all, of it loss. The hash mark should for a “T”. Big Players may think the stock has sunk enough, and may be ready to pick up shares.

Stop Orders Can Help When You Have to be Away

You can’t seem to find enough time to spend in front of the computer every day, keeping a close eye on your options, is a common problem. Life always gets in the way.

Don’t fret. By using a sound set of investing rules, you can still succeed at investing, even if you can’t follow stocks throughout the day.

Consider using buy-stop and sell-stop orders. These trades allow you to set a certain price at which you can buy or sell a certain number of options on any stock or ETF.

For instance, you’ve researched and done your DD on a hot bio company. It owns strong sales and earnings and tops a leading sector and industry. The broad market is in a clear uptrend.

You evaluate the stocks technical action now that it has passed your required fundamentals, and sure enough, the stock has formed a solid support area on light volume and now you see volume coming into the stock over the past few days as it begins to give signals of turning up.

You want to grab an at the money option as it breaks out. You can set a buy-stop limit order at the point that you would like to buy. If the break out point is 50.75 stock price you could set the buy order for the option at its premium of 3.90. That way, if the stock hits that point, your broker will automatically execute an order for you at that price.

The same can be done on the sell side. A sell-stop market order will prompt your broker to sell your shares at that price once the market hits a certain point. As sell- limit order (rather than market-sell order) will ensure it doesn’t get sold beyond a certain price level.

There is one notable disadvantage to this strategy. It doesn’t account for volume changes. If a stock crosses its optimal buy point (the point and price you set) but volume comes in below average, that’s not a strong breakout. On a break out buy strategy, volume should swell to 50% or more above normal levels during a bullish breakout.

If your buy-stop order gets triggered and you later see that volume was weak, you should sell at least a portion of your options. If volume picks up later, you can buy back in.

Option Traders’ Chatroom

Now that the book is on bookshelves, it will take a little while to build a community of option traders; nonetheless, we are providing a 24/7 live chatroom. To start, we will schedule chats Monday, Wednesday, and Friday at 8:00PM,  EST time. Wendy will be online to answer questions at that time.

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The room will be open 24 hour a day for the convenience of the developing community, the relationships that will form, and to accommodate various time zones. We no doubt will have members from Canada, England and beyond???

We look forward to chatting with you.

Make it a happy day!