Why Delta Dollars Will Change Your Option Trading Forever

by Gavin in Blog, Options Trading tutorials

November 1, 2017 • 6 comments

Delta is one of the four main option greeks, and any serious trader needs to have a thorough understanding of this greek if they hope to have any chance of success in trading options.

If you’re a beginner visit my article to learn more about understanding option delta.

Most serious traders probably have a pretty good grasp of delta.

However, there is one metric related to delta that I use religiously in my trading and that is Delta Dollars.

Contents

• What Is Delta Dollars?
• Why Is It Important
• Practical Example
• Conclusion

What Is Delta Dollars?

Delta Dollars is quite simply the position delta x the underlying price. It is sometimes also referred to as Delta Notional.

We know that delta gives us the share equivalency ratio, so if we own a long call with delta 0.40 it is equivalent to being long 40 shares of the underlying.

Let’s assume the stock is trading at $100. The Delta Dollars figure would be 40 x $100 = $4,000.

This tells us that the option position is equivalent to having $4,000 invested in the stock.

The Delta Dollars figure is going to depend a lot on the price of the stock.

Let’s say that instead of the stock trading at $100, it was trading at $500. Our Delta Dollars figure in this example would be 40 x $500 = $20,000.

Perhaps now you can understand why it’s important to look at the Delta Dollars number and not just the delta.

Why Is It Important?

Delta Dollars tells us our overall directional exposure in the market.

If our account size is $50,000 and our delta is 40, that doesn’t really tell us much.

But if our Delta Dollars exposure is $200,000 then we know that it is too high for our account size.

Personally, I like to set a rule that I don’t let my delta dollar exposure get above 50% of my account size.

More conservative traders might like to set that rule at 25%, whereas more aggressive traders might set it at 100%.

It’s personal preference, but the first step as a delta neutral trader is to start paying attention to Delta Dollars and then develop rules around this metric.

I also have rules regarding the delta dollar exposure for each trade and strategy.

Practical Example

For an iron condor, I usually set a 200% rule for Delta Dollars.

Assume you have an iron condor on RUT that is risking $20,000. If the Delta Dollars figure gets above plus or minus $40,000 you might want to think about adjusting and getting back closer to neutral.

Conclusion

Delta Dollars is a little known, but very important metric when it comes to option trading. Interactive Brokers provides this information as part of their Risk Navigator.

For traders using other platforms, it is very easy to calculate this number yourself. Just take the overall position delta and multiply it by the underlying stock or index price.

For delta neutral traders, it is important to not let the Delta Dollars exposure get too far away from neutral and rules can be created about when to adjust a position depending on trade size and account size.

Trade Safe!

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.