Systematic trading: The key to beating the market

Prior to the knowledge of Greeks, if a trader had a bullish view, he would have bought a call option or collected the premium by selling a put option. However, the knowledge of Greeks equips him with a strategic view. For example, if the trader has a bullish view and expects the market to move from 19200 to 19240. Now he knows that he will select an ATM option strike price with a Delta value of 0.5 because, if the market moves by 40 points, he will get a 20-point move in the option. There is a difference in the thought process of the trader now. Trading is well defined and quantitative in nature.

The expectation of a 20-point move in the option premium was an outcome of the application of the following formula.

Expected change in option premium = Option Delta * Points change in underlying asset

Formula is just a basic one. As we gain an insight into the other Greeks trading would be more quantitative and scientifically streamlined. Traders who trade randomly may be successful, but it could be just a fluke trade. In option trading we need to have a proper system-based trade for accuracy.

We looked at the significance of Delta and understood how one can use delta to evaluate the expected change in premium. Before we proceed any further, here is a quick recap.

• Call options have a +ve delta. A Call option with a delta of 0.4 indicates that for every 1-point gain/loss in the underlying the call option premium gains/losses 0.4 points.
• Put options have a –ve delta. A Put option with a delta of -0.4 indicates that for every 1-point loss/gain in the underlying the put option premium gains/losses 0.4 points.
• OTM options have a delta value between 0 and 0.5, ATM option has a delta of 0.5, and ITM option has a delta between 0.5 and 1.

Let us understand better with an example. Assume Nifty Spot is at 19312, strike under consideration is 19400, and option type is CE.

• What is the approximate Delta value for the 19400 CE when the spot is19312?

Delta should be between 0 and 0.5 as 19400 CE is OTM. Let us assume Delta is 0.4

• Assume Nifty spot moves from 19312 to 19400, what do you think is the Delta value?

Delta should be around 0.5 as the 19400 CE is now an ATM option.

• Further assume the Nifty spot moves from 19400 to 19500, what do you think is the Delta value?

Delta should be closer to 1 as the 19400 CE is now an ITM option. Let us say 0.8.

• Finally assume the Nifty Spot cracks heavily and drops back to19300 from19500, what happens to delta?

With the fall in spot, the option has again become an OTM from ITM, hence the value of delta also falls from 0.8 to let us say 0.35.

What can you infer from the above 4 points?

Clearly as and when the spot value changes, the moneyness of an option change, and therefore the delta also changes.

To conclude, observe that the delta changes with changes in the value of spot. Hence delta is a variable and not really a fixed entity. Therefore, if an option has a delta of 0.4, the value is likely to change with the change in the value of the underlying.

(The author is a homemaker, who dabbles in stock market investments in free time)