Our family has a dog named Hans who loves retrieving tennis balls. Hans will pester you night and day to throw him the ball. And if there happens to be more than one tennis ball lying around, he will put as many as he can into his mouth. One ball is easy for Hans to manage. But, if there is more than one ball, Hans begins to lose focus and, with each additional ball, it becomes more complicated for him to keep them in his mouth. The same can apply for those who trade the markets. One trade is easy to focus on, but adding more positions, with varying sizes, can make trading much more difficult to manage.
Delta is the rate of change. That definition is what one will often hear when talking about options. It has little meaning to the novice investor. Delta may be better understood by thinking of it in terms of shares of stock. Consider the following: if you own 77 shares of stock and the stock goes up a dollar, you would have made $77 dollars. If you own an option with 77 deltas, and the stock goes up a dollar, you would also make the same $77 dollars. So, a better working definition of delta is the number of shares you are trading. If you have multiple contracts in a trade, then your deltas would be multiplied (5 contracts x 80 deltas = total of 400 deltas.) That trade has 400 deltas, or would act like your trading 400 shares. The more shares one holds, the more deltas the portfolio has. So, delta can be thought of as the amount of risk or exposure to the market. If you are trading 1,000 deltas in a portfolio, you would have considerably more risk in your account than if you were only trading 100 deltas, so the larger the portfolio’s deltas are, the more the portfolio is exposed to market movement. Therefore, managing deltas is of the upmost importance to the individual trader.
Knowing when the markets are overbought and oversold can be pivotal points of interest for your total deltas. If markets are at tops, reducing deltas may help reduce the risk to a portfolio. How does the individual trader shrink the number of deltas one holds in a portfolio? Exiting trades and placing bearish trades that come with negative deltas will both reduce deltas and exposure to market conditions. If the markets have found a level of support and the markets are expected to go up, adding deltas to a portfolio may add to your returns.
In the end, a delta is a quick an easy way to view your portfolio and a mathematical value that quickly shows the amount of risk that one has to their portfolio. If Hans could talk, he would tell you one ball provides more focus, more enjoyment and less anxiety. And like one ball, a portfolio delta provides a single number, better focus and clarity to your bottom line.