Add up the Deltas
The Delta has an interesting ability – it can be summed up!
Let me explain – we will revisit the Futures contract. We know if there is a change of 1 point in the spot value of the underlying, then it means Futures changes by the same amount.
For example, when Nifty Spot moves from 8340 to 8350, we see that Nifty Futures also shifts from 8347 to 8357 (with an existing value of 8347 when Nifty Spot was at 8340). Therefore, if we assign a delta value to this Futures, it would be 1 as every 1 point move in the underlying brings an equivalent change in the Futures.
Assuming I buy 1 ATM option with a delta of 0.5, it is equivalent to possessing a half futures contract. Consequently, with 2 such ATM contracts, the total delta is equal to possessing 1 futures contract. Thus, the deltas of two or more option contracts can be combined to determine the overall delta of the position.
We can use a few examples to gain more knowledge on this subject.
Case 1- The Nifty spot is currently at 8125 and a trader has 3 distinct Call options.
In case 2, with the Nifty spot at 8125, the trader has a mixed position consisting of both call and put options.
Case 3 – Nifty being at 8125, the trader has a combination of Call and Put options. He has 2 lots of Put options.
In Case 4, when the Nifty spot is at 8125, the trader holds both Call options and Put options with the same strike price and underlying asset.
In Case 5, the Nifty spot is at 8125, and the trader has sold a Call Option.
Let’s consider a scenario where the trader has a long position of 5 lots of deep in-the-money (ITM) options. We know that the total delta of such a position would be +5 * +1 = +5. This means that for every 1 point change in the underlying asset, the combined position would change by 5 points in the same direction.
It’s important to note that the same effect can be achieved by shorting 5 deep ITM put options. In this case, the calculation would be -5 * -1 = +5. The -5 indicates 5 short positions, and -1 represents the delta of the deep ITM put options.
This case study should have given you insight into the process of summing up the deltas of individual positions to determine the total delta. This technique can be very helpful when managing multiple options simultaneously and determining their combined directional effect.
I strongly advise you to always consider the change in each position when evaluating your overall position, as this will give you an idea of the risk and leverage associated with it.
Here’s something to note:
Delta of ATM option = 0.5
When you have 2 ATM options, the total delta of the position would be 1.
For every point movement of the underlying, the overall position changes by one due to the delta value being one. This demonstrates how similar an option is compared to a Futures contract. However, it is important to note that these two instruments should not be seen as equivalents. The Futures contract is only impacted by market direction whereas options can be affected by a variety of variables beyond just price direction.
If you want to explore the margin perspective, consider an options contract rather than a futures contract. Be aware of its implications first, and we’ll discuss this further later on.