Commodity Research Bureau Delta Options Trading Course

8/13/2019 Commodity Research Bureau Delta Options Trading Course

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Bringing Commodities and Futures Research, Data,

and Analysis to Traders for over Seventy-Five Years

A COMMODITY RESEARCH BUREAU PUBLICATION

TRADINGCOURSE

DELTAOPTIONS


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Reproduction or use of the text or pictoral content in any manner withoutwritten permission is prohibited.

Copyright 1934-2011 Commodity Research Bureau - CRB,a Barchart.com, Inc. company. All rights reserved.

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The information herein is compiled from public sources believed to be reliable but

is not guaranteed as to its accuracy or completeness. No responsibility is assumedfor the use of this material and no express or implied warranties are made. Nothingcontained herein shall be construed as an offer to buy/sell, or as a solicitation to buy/sell, any security, commodity or derivatives instrument.

These materials are reprinted from The Delta Options Trading Strategy.It was initially published in 1994 by The Ken Roberts Company. Thesematerials are reprinted for informational purposes only, and are not related toThe Greatest Business on Earth. The Greatest Business on Earth makes nowarranties or representations regarding the accuracy of the information, or

the effectiveness of trading strategies contained in these materials.


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One characteristic that all successful traders seemto share is their ability to fully understand the markets

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Delta Options Trading Course

Copyright 2009 Commodity Research Bureau www.crbtrader.com

THE FUTURES MARKETS BEST-KEPT

SECRET

DELTA, The fourth letter of the Greek alphabet, [] representschange and is used in modern day mathematics to describe the

relationship between variables.

Be aware that investment in commodity futures and options for

potential prot is accompanied by the risk of loss. Your decision

to trade commodities should be based on your particular nancial

circumstances and trading objectives.

INTRODUCTION

Every time we invest we want to maximize our chance of making a protand at the same time carefully limit our exposure to loss. Futures tradingoffers tremendous chances for huge prots, but there are always chancesof substantial losses too. To be successful as futures traders, we must doeverything possible to control the size and the frequency of losses. Everyprofessional futures trader ranks risk control as the most important tool for

successful, protable investing. If the losses can be controlled, the big protswill eventually roll in. That is simply how the futures markets work.

There are many ways to approach risk control, but most of them alsoput a cap on the chance of really hitting a big pay-off. In return for safety,prot potential is usually given away. There is, however, a powerful tradingsecret that gives you both edges of the sword: TOTAL RISK CONTROLand UNLIMITED PROFIT POTENTIAL! In this, The Worlds Most Powerful

Money Manual & Course Bonus Pak. I will teach you the best big money-making and, at the same time, risk-controlling techniques ever discovered:DELTA OPTIONS trading. With DELTA OPTIONS trading, you canactually DOUBLE or TRIPLE the size of your prots and at the same time,COMPLETELY limit your risk. Of course there is some cost to this powerfultool, but it can be a very low cost relative to the prots of DELTA OPTIONStrading. After working through this Bonus Pack you will understand thetechniques, risks and huge reward potentials of DELTA OPTIONS tradingand will be ready to use this new power-trading secret.
http://www.crbtrader.com/http://www.crbtrader.com/


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To start with, we must learn some fundamental principles about futuresoptions trading. With these principles in hand, I will reveal the methodsof successful DELTA OPTIONS trading used by top professional traders.Remember, the subject of options trading can seem quite complex. Dozens

of long textbooks, full of complex equations and terminology, have beenwritten about options. As a result, most people have even been fooled intothinking that options trading is just too complex for them to understand. I amglad it seems that way, because this leaves substantial prot opportunitieswaiting for those few of us willing to take advantage of them! There are manyways to make money trading options in fact, we have produced an entirecourse dedicated just to making money with options. DELTA OPTIONStrading is simply one of the most effective methods of harvesting these protopportunities. As with every power-trading technique, there are specic

times when it should be used to magnify prot opportunities, and other timeswhen it is not very useful. We will conclude this manual with a section on thetechniques for choosing the right DELTA OPTIONS trades.

LEARNING THE ABCs OF OPTIONS

OPTIONS trading involves learning just SIX WORDS and completelyunderstanding their meanings. It can be that simple! So, our rst job is

to learn these words. After learning the basic six, there is one more wordto learn, the magic seventh word: DELTA. Remember, there are just sixwords and a magic seventh word that hold the key to prots in optionstrading! So lets get to work!

WHAT IS AN OPTION?

When we purchase an option, we are buying the right to do somethingduring a specic period of time to come. We do not have to do it, but we

own the right to do it. A futures option is the right to buy (a CALL option) or,alternatively, the right to sell (a PUT option) a particular futures contract ata set price (called the STRIKE PRICE) during a limited period of time. Thetime the option ends is called the EXPIRATION, and the price we must payfor the option is called the PREMIUM.

These are the rst ve words. By the end of this course, you willunderstand them and be able to use them. For a specic trading example,


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we will look at using options to trade in the Gold market. Gold is just oneexample of a market we can trade using options. Everything said here aboutGold options applies equally to all the other markets with options too. Theseinclude the stock indexes, Silver, Oil, Treasury Bills and Bonds, foreigncurrencies, grains, meats, Sugar, and many more. In fact, every major

market with enough price action to make people wealthy can be tradedthrough the use of options. But for our examples, lets now just talk aboutGold.

Suppose we believe the price of Gold is going to rise over the nextfew weeks. We can purchase an option to buy Gold (an option to buy is aCALL option) at a set cost per ounce, during a period of time xed by theEXPIRATION date of the option we choose. This set cost at which we canbuy Gold is called the STRIKE PRICE of the option. The amount of time we

have to use, or exercise, this option is set by the EXPIRATION date. We canchoose an EXPIRATION date many months away, a few weeks away, or justa few days away. Which EXPIRATION we choose depends on the period oftime in which we think Gold will move up to our target price. The option canonly be used, or exercised, on or before that EXPIRATION date.

Of course, this option is going to cost us something. As with everythingelse in the world, what it costs depends on what people think it is worth. Theprice we will pay the person selling us the option is called the PREMIUM.Once we have purchased this CALL option, we have an irrevocable rightto buy Gold at the STRIKE PRICE of the option at any time up until theEXPIRATION date specied by the option. We have locked in the price wewill pay for Gold no matter how high it might go. Even if the price of Goldgoes way above the STRIKE PRICE of our option, we can buy it at the lowerprice set by the STRIKE PRICE of our option. This is our prot potential inowning the option, and if Gold does make a big move, that prot can behuge relative to the price we paid for the option! Alternatively, if we are wrong

in our vision of the direction Gold prices will take and the price of Gold goescrashing downward, we will have lost only the PREMIUM, or price we paid,for our option. The advantage of this strategy is a limited risk we onlyrisk the amount we paid for the option, the PREMIUM and yet we retainunlimited upside prot potential if Gold prices do indeed rise.


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THE SIX WORDS

Look back over the capitalized words. These are the rst ve of the sixwords. Re-read this and dene each of the words in your own words as youread. Then we will move on with our discussion and learn the sixth word,

VOLATILITY.

DEFINE EACH OF THESE WORDS:

1. CALL2. PUT3. STRIKE4. PREMIUM5. EXPIRATION

OPTIONS TRADING: BACK TO GOLD

Now that we have read through the basics, lets examine a few possibletrades. Suppose a few months ago we had suspected that Gold prices wereready to move up, but we did not want to take the risk of entering a futurescontract trade. Gold was trading at $420 an ounce. We decided to buy anoption.

PUT AND CALL

First question: What would we want to buy, a PUT or a CALL?

We would, of course, wish to buy a CALL option. A CALL gives us theright to buy the futures contract at a specic price, called the STRIKEPRICE. A PUT would give us the right to sell at a specic price, and wewould use a PUT if we thought prices were going down. But we think theyare going up. So we purchase a CALL option. That was the easy question.The next two questions are going to take a little more review and discussion.

STRIKE AND PREMIUM

Next question: What STRIKE PRICE should we purchase and how muchPREMIUM will we pay?


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If we look in Investors Business Daily or The Wall Street Journal, wesee there are many possible STRIKE PRICES, all with different prices, orPREMIUMS. Which one do we want? There is a STRIKE PRICE every $20,that is at 400, 420, 440, 460 an ounce and so on. The closer the STRIKEPRICE is to the current trading price, the higher the PREMIUM and the more

the option costs (remember, the PREMIUM is the cost of the option). Thefurther the STRIKE PRICE is above the current price of Gold, the lower thePREMIUM for buying the option. We might think of each STRIKE PRICEoption as a different commodity. While prices will move in similar directions,each will behave a little differently.

Exactly how much each Gold option costs depends on how likely tradersin the market believe it is that the price of Gold will reach and exceed theSTRIKE PRICE of the option. If we purchase the 460 STRIKE Gold option

when Gold is trading at $420 an ounce, Gold will have to move up over $40an ounce before our option would be worth using. There is no sense in usingour option to buy Gold at $460 an ounce if we can simply go out and buyGold on the market at a price less than that. But if Gold does move up, sayto $480 an ounce, we can protably exercise the option. We have the right tobuy it at $460! We can exercise our option and buy the Gold at $460 (our setSTRIKE PRICE), and then if we wish, immediately sell it back at the currentmarket rate of $480. By doing this, we pocket a prot of $20 per ounce. EachGold CALL option gives the right to buy one futures contract of 100 ounces,so we would be able to make a quick $20 an ounce on 100 ounces, or a totalof $2,000 ($20 x 100 ounces)! To determine our net prot on this transaction,we must deduct from the $2,000 we receive at sale, the original cost orPREMIUM, we paid for the option.

STRIKE AND PREMIUM

Next question: What STRIKE PRICE should we purchase and how much

PREMIUM will we pay?

If we look in Investors Business Daily or The Wall Street Journal, wesee there are many possible STRIKE PRICES, all with different prices, orPREMIUMS. Which one do we want? There is a STRIKE PRICE every $20,that is at 400, 420, 440, 460 an ounce and so on. The closer the STRIKEPRICE is to the current trading price, the higher the PREMIUM and the morethe option costs (remember, the PREMIUM is the cost of the option). Thefurther the STRIKE PRICE is above the current price of Gold, the lower the


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PREMIUM for buying the option. We might think of each STRIKE PRICEoption as a different commodity. While prices will move in similar directions,each will behave a little differently.

Exactly how much each Gold option costs depends on how likely traders

in the market believe it is that the price of Gold will reach and exceed theSTRIKE PRICE of the option. If we purchase the 460 STRIKE Gold optionwhen Gold is trading at $420 an ounce, Gold will have to move up over $40an ounce before our option would be worth using. There is no sense in usingour option to buy Gold at $460 an ounce if we can simply go out and buyGold on the market at a price less than that. But if Gold does move up, sayto $480 an ounce, we can protably exercise the option. We have the right tobuy it at $460! We can exercise our option and buy the Gold at $460 (our setSTRIKE PRICE), and then if we wish, immediately sell it back at the current

market rate of $480. By doing this, we pocket a prot of $20 per ounce. EachGold CALL option gives the right to buy one futures contract of 100 ounces,so we would be able to make a quick $20 an ounce on 100 ounces, or a totalof $2,000 ($20 x 100 ounces)! To determine our net prot on this transaction,we must deduct from the $2,000 we receive at sale, the original cost orPREMIUM, we paid for the option.

VOLATILITY

How much PREMIUM will we have to pay for our Gold CALL option?

Remember, to obtain the prot in the above example, the price of Goldhad to move from $420 per ounce to $480 per ounce, and this is a prettybig move. So how much is that option with a 460 STRIKE going to costus to begin with? Well, that depends on how likely traders in the marketthink it is that Gold will make a big move up. If the price of Gold has beenrather steady, and there have been few major moves, traders will gure the

chances of Gold making a big move upwards are rather small. It will notcost very much to buy a Gold option with a STRIKE PRICE way beyondwhat traders think it is likely to be worth during the life of the option. Thisperception of how active a market is and how likely it is to make a big moveis called the VOLATILITY of the market the sixth word in our glossary ofoption trading. When VOLATILITY in a market is low, it means prices arevery stable and big moves in price seem unlikely. When VOLATILITY is high,the market is making big price moves.


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Under circumstances where VOLATILITY is low, the person selling theoption to us gures it unlikely he will actually have to deliver on the optionhe gures prices seem pretty stable and are not likely to go up above theSTRIKE PRICE, or not very much above the STRIKE PRICE. So if Gold isselling for $420 an ounce and prices are stable (low VOLATILITY), we may

have to pay only a very small PREMIUM for the 460 STRIKE option, aslittle as $50 or $100. The more active prices have been, and the more likelyit appears that Gold may move up to the $460 per ounce STRIKE PRICEof our option, the more the option will cost.If prices have been very active,that is, very VOLATILE, and moving upward, the option PREMIUM could beseveral hundred dollars.

Either way, if prices actually do reach $480 an ounce, we can exerciseour option and pocket the $2,000. Our net prot on the trade is this amount,

$2,000, minus the PREMIUM we paid for the option. If we paid a lowPREMIUM of $100 for the option, our net prot was $1,900, twenty times thecapital we risked! If we paid a PREMIUM of $400, as we would have duringthe Spring of 1987, when prices were VOLATILE, and the PREMIUMStherefore higher, we still would have had a net prot of $1,600, or an 800%gain. In either case, if we had been wrong about the direction of the pricemove, the most we could have lost was the PREMIUM we originally paid.

Please note, you dont have to exercise your protable option. You cansell it to someone else for a nice prot.

So back to the rst part of our question, what option STRIKE PRICEshould we buy?

The answer depends partly on how much we want to spend on the optionPREMIUM. The STRIKE PRICES closest to the current trading price of Goldwill always be the most expensive. These are the options most likely to pay

off. Some STRIKE PRICES will even be below the current price of Gold, forexample, a 400 strike option when Gold is at $420. These options that arealready in-the-money are the most expensive. The 400 STRIKE optiongives one the right to buy Gold at $400 an ounce when it is currently sellingfor $420 an ounce. This option will cost at least as much as the $20 anounce it is already worth (its current intrinsic value).

Generally it is best to buy the option with a STRIKE PRICE one or twosteps away from the current market price of the futures contract. In this case


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when Gold is trading at $420 an ounce, it is probably best to buy the 440STRIKE PRICE option. If VOLATILITY is high, we might want to considerthe 460 STRIKE option, but we must always remember that the farther awaythe option STRIKE PRICE is from the current price of Gold, the less likely itis that we will make money on the option. When we buy a distant STRIKE

PRICE (a far-out-of-the-money strike), we pay less money, and have lessrisk, but we usually also have a lower chance of making a prot.

TIME IS MONEY

The third question: Which EXPIRATION time should we choose for ouroption purchase?

In answering this question always remember: TIME IS MONEY! Themore distant the EXPIRATION DATE (the longer the period we have toexercise the option), the more we will pay for the option (the higher thePREMIUM will be). The reason for this is simple:No one knows, to the bestof my knowledge, what the future will bring. It is possible to make reasonableguesses about the near future based on current circumstances, but aboutmore distant events we will always be ignorant. The farther into the futureour CALL option to buy Gold extends the more distant the EXPIRATION ofthe option the more that option will cost.

The EXPIRATION DATE of each option is set by the exchange whereit is traded. Each futures contract has multiple different delivery monthsthroughout the year. Usually these are spaced one, two, or three monthsapart, and we can trade options on any of these coming months. Whentrading options, always discuss with the broker the exact EXPIRATIONDATE of the option. We must know how much time remains untilEXPIRATION, because this is our period of opportunity. We should note thatthe option frequently will expire in the month before the futures delivery date.

For example, an option on February Gold futures will expire in January. Byselecting options on futures contracts with deliveries nearer or further awayin time, we can pick an EXPIRATION DATE for the options contract that isanywhere from thirty or less days away, to many months away.


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FACTORS THAT AFFECT THE PREMIUM BEFORE

EXPIRATION

Every day we own the option, chances increase that something willhappen to change the price of Gold. Given enough time be that months or

even years it is very likely something WILL happen to drive the price of Goldup and make our option very lucrative. This is called the TIME PREMIUM.

A large part of the PREMIUM we pay for an option consists of this TIMEPREMIUM, the chance that something unknown and unexpected willhappen to change prices and make the option protable. The more time untilEXPIRATION of the option, the more chance there is that circumstancesand prices will change. In purchasing an option, we pay the person sellingthe option for his willingness to accept the risks of time and those unknownevents which may make the option a good investment for us.

If nothing happens and prices stay the same, the person who sells usthe option wins and pockets all, or part of our money. We have lost thePREMIUM we paid, but nothing more. If, however, things do change, andprices move as we thought they might when we bought our option, then wepocket the prots. Thats why we bought the option in the rst place!

The more VOLATILE the market, the more we will pay for time.

VOLATILITY implies there is a greater chance that things will change, givenenough time. So our PREMIUM will go up. When we buy an option, we aretruly buying time, and all the chances that time offers. The more time we buy,the more we will pay. How much time to buy (how distant an EXPIRATION)depends on our market strategy. With most trading strategies, it is unwiseto buy an option much more than 90 days long. The PREMIUM paid for anoption longer than this is usually just too high. Sometimes, time does costtoo much!

If only a few days remain until EXPIRATION, options with a STRIKEPRICE far removed from the current trading price of the futures will beessentially worthless. This happens when the STRIKE PRICE is so far awayfrom the current trading price that it is impossible, given current VOLATILITY,for prices to move to or beyond the STRIKE PRICE in the options remainingtime. As the EXPIRATION DATE of an option approaches, and the timeremaining to exercise the option decreases, the PREMIUM (cost) of theoption will usually decrease. When the time remaining until EXPIRATIONis short, there will be very little time value in the PREMIUM paid for the


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option. When there is little opportunity time left in the option, we pay littlefor it.

WHAT HAPPENS AS EXPIRATION APPROACHES

As the EXPIRATION DATE for the option approaches, the PREMIUMcost of the option will reect more and more the intrinsic value of the option.Time, and the opportunity value of time, has wasted away. If the option isfar-out-of-the-money (the STRIKE PRICE is distant from the current priceof the futures), the PREMIUM will be very small. This happens when tradersdecide there is very little chance prices will reach the STRIKE PRICE of theoption and give it value in the time remaining until EXPIRATION.

Some options will be in-the-money as EXPIRATION approaches. Fora CALL option, this means that the STRIKE PRICE is less than the currenttrading price of the future. For example, a Gold option with a STRIKE PRICEof 460 is in the money when Gold is trading at 480. In this instance, theoption is worth at least $20 an ounce, because it grants the right to buyGold at $460 an ounce (the STRIKE PRICE), $20 an ounce below thecurrent market price of Gold futures. This is called the intrinsic value ofthe option the amount it is worth in cash if it is exercised. As EXPIRATIONnears, the PREMIUM of an in-the-money option will approach its intrinsic

value, and there will be no additional time value added to the PREMIUM.At EXPIRATION, the value of the option is equal to its intrinsic value. Foran option which is out-of-the-money, there is NO intrinsic value. The valueof the out-of-the-money option is based on its time, or opportunity, valuethe chance that time will change prices and give it intrinsic value. As timepasses, the chance of this happening diminishes, and this value disappears.

At EXPIRATION, there is no time left, and the out-of-the-money optionis worthless. When trading options we must always remember, TIME ISMONEY.

For each trading month of a futures contract, there will be a number ofoptions with different STRIKE PRICES. Each of these should be viewed asa slightly different commodity. While they will all undergo changes in valuebased on changes in the price of the futures, they will change at differentrates and in different amounts, depending on how close the STRIKE PRICEof each is to the current trading price of the futures. Options on differenttrading months of futures move differently in value because of differencesin their times until EXPIRATION. There are relationships between all the


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options on a given futures contract since they all vary in a specic relatedway with the futures prices, but it can take some time and study to visualizethese relations.

THE SIX WORDS

There you have the six key words of options trading: CALL, PUT, STRIKEPRICE, EXPIRATION, PREMIUM, and VOLATILITY. Do you understandthem? If so, you are ready to explore the magic SEVENTH WORD: DELTA.

DEFINE EACH OF THESE WORDS AGAIN, AND MAKE

CERTAIN YOU UNDERSTAND THEM:

1. CALL2. PUT3. STRIKE PRICE4. PREMIUM5. EXPIRATION6. VOLATILITY

THE MAGIC OF DELTA

DELTA means CHANGE. Change is the key to all prots. It really is amagical principle; without change, there is no opportunity, no progress, nogrowth. In futures option trading, DELTA reects the amount of value of anoptions change relative to the change in value of the underlying futurescontract. An understanding of how option DELTAS work is the key tounderstanding DELTA OPTIONS.

The value of an option depends on how likely traders in the market think

it is that prices of the underlying futures will exceed the STRIKE PRICE ofthe option. Look at this example: It is now January and April Gold futures arecurrently trading at $470 an ounce. We decide to buy one CALL option forthe April Gold contract with STRIKE PRICE of 500. This option has 60 daysleft until EXPIRATION. Remember, the CALL option gives us the right to buyGold at $500 an ounce any time during the next 60 days, up until mid-March,at which time the option expires (an option on the April futures contractusually expires in March always check the actual date with your broker). Thisoption PREMIUM, or cost, is $2.50 per ounce on the 100 ounce contract,


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which works out to a total dollar cost of $250.

But Gold is trading currently at $470 an ounce, well below the 500STRIKE PRICE of the option. What will happen to the value of this option inthe next week or two if the price of Gold goes up? Suppose in the next few

days the price of Gold increases to $480 an ounce, what happens to thevalue of our option?

The question we are asking is simply, how much will the value of ouroption increase for every dollar that the price of Gold increases? This iswhere the concept of DELTA enters DELTA is change. Here is the denitionof DELTA: The DELTA of an option contract is the amount the price of anoption will increase or decrease with each increase or decrease in the priceof the futures contract. In this example, the DELTA tells us how much the

price of an option will change with each change in the price of the April Goldfutures, and the Gold futures contract our CALL option gives us the right tobuy.

The answer to our question depends on how close the current tradingprice of Gold is to the STRIKE PRICE of our option, and how much timeremains until EXPIRATION. There are complex mathematical equations thatcan be used to calculate what the DELTA should be, but I will teach you howto gure it out very simply using a few days information obtained from TheWall Street Journal, Investors Business Daily, or your broker. I will also teachyou some rules-of-thumb for estimating the DELTA values without using anycalculations at all.

CALCULATING DELTAS

In our example above, we purchased a CALL option with a 500 STRIKEPRICE when Gold was trading at 470. We paid $250 for this option It is now

5 days later, and the price of Gold has increased to 480. Did the value ofour option change is it now worth more than $250? The answer is of courseyes, but how much? First, what happened to the price of Gold? The price ofGold went up $10 per ounce, so the value of a 100 ounce futures contractincreased by $1,000 ($10 per ounce x 100 ounces). What happened to theoptions PREMIUM? Our options PREMIUM, or value, did not increase asmuch as the futures price did. After all, the price of Gold is still below ourSTRIKE PRICE by $20, but the price of Gold is now closer to the STRIKEPRICE, and there is a greater chance now that it WILL exceed the STRIKE


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PRICE. The PREMIUM, or value, of the option has increased. If we look atThe Wall Street Journal, we will see that our April Gold CALL option with a500 STRIKE PRICE is now worth $4.50 an ounce, or $450 ($4.50 per ouncex 100 ounces).

Instead of waiting longer for the price of Gold to go higher and also takingthe risk of prices instead declining we could now sell our option back at thecurrent trading price of $450. This would result in our pocketing a $200 prot($450 received on sale of the option minus $250 paid for the option = $200prot). That is more than an 80% return in ve days! We can alternativelychoose to hold the option longer and hope Gold prices continue to rise.Remember, by holding the position, we also accept the risk that a decline inGold prices will cause our CALL option to lose value.

In this example, the price of Gold increased $10 an ounce (from 470 to480), but the value of our option increased only $2 per ounce (from 2.50to 4.50). This means that for every dollar the price of Gold increased, ouroption increased $0.20 or 20% of the futures price change. Remember,DELTA is the amount the option value changes per change in the futuresprice. This can be thought of as a percent of the futures price change.

HERE IS THE KEY FORMULA FOR CALCULATING DELTA:

In this instance, the DELTA equals: [a] the amount the option priceincreased, $2; divided by [b] the amount the futures price changed, $10.This is equal to 0.20 (2/10 = 0.20). For every dollar that Gold prices rise, theoptions price will move up 20 cents. This is the same as saying the optionsvalue changed by 20% of the futures price move.

MAGIC IN THE AIR

The DELTA of an option is NOT FIXED. It varies with the futures price.Asthe price of Gold approaches and exceeds the STRIKE PRICE of our option,the DELTA will increase. That is to say, the value of the option will increaseby a larger amount for every dollar move in the futures price as the price ofthe futures approaches and exceeds the STRIKE PRICE.

In our example, the price of April Gold is now at $480. Suppose in thenext two days it makes a big move up again, to $490.What will happen to the


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value of our option? Well, we calculated the DELTA before to be 0.20. Usingthat DELTA, we would expect our option PREMIUM to increase 20% of (or0.20 times) the change in the futures price. The change we might expectin the options value is then 0.20 x $10 = $2. That would mean our optionPREMIUM, or value, would increase by another $200 ($2 per ounce x 100

ounces).But the answer is actually better than that!

As the futures price gets closer to the STRIKE PRICE, the DELTAincreases. That means the value of the option increases by a largerincrement for every increased in the price of Gold futures. The futures pricehas increased from $480 to $490 an ounce. If we look at The Wall StreetJournal we will see that the PREMIUM of our option has now increased$3.10 from $4.50 to $7.60 an ounce. The futures price increased $10, from$480 to $490 per ounce.

For every $1 change in the price of Gold, our option has changed $0.31,or 31% of the change in Golds price. Notice that the DELTA is increasing asthe price of Gold moves closer to the STRIKE PRICE of our option. We aremaking MORE money for each dollar increase in Golds price as the pricemoves up. In the move from 470 to 480, we made $0.20, or 20%, for every$1 increase in the price of Gold. As the price increased from 480 to 490, wemade $0.31, or 31%, for every $1 gain in Gold prices. Our option is gainingvalue faster as the price of Gold gets closer to our STRIKE PRICE! This

is the magic of DELTA as prices move in our direction, we actually makemoney faster, our options value increases by larger and larger percentagesof the change in Golds price! The reverse also holds, as prices move awayfrom us, we lose money more slowly as the DELTA decreases. As pricesmove against us, our options value decreases by smaller and smallerpercentages of the change downward of the futures price.

What happens if the price continues to move up? If the price moves to500, the STRIKE PRICE of our option, we will make $0.50, or 50% for every


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$1 move in the Gold futures prices. Should the price still move higher, theDELTA will continue to increase until it approaches a value of 1.00, or 100%.When the DELTA is 1.00, the option PREMIUM will change 100% of thechange in the Gold futures price. A $1 move in the price of Gold will produceexactly the same $1 move in the option PREMIUM (or dollar value). This

occurs when the option is far-in-the-money, when Gold futures are tradingfar above the STRIKE PRICE of our CALL option.

I have enclosed a graph of DELTA values to illustrate how DELTASchange with changes in price. Look at Figure 1 on the next page. This graphshows how DELTA changes for a Gold option with a 500 STRIKE PRICE asthe futures price varies between 450 and 550. On the graph, we have thefutures prices listed along the bottom and the DELTA values up the side.Notice it is an S shaped curve. As the DELTA of the option decreases

rapidly, then levels off near zero. Notice that when the futures price is at theSTRIKE PRICE, the DELTA is approximately 0.50. THIS IS A GOOD RULEOF THUMB. An option DELTA will roughly be around 0.50 when the futuresprice is at the option STRIKE PRICE. This means that when the futures priceis trading close to the STRIKE PRICE, the value of the option will changeabout 50% of the change in futures that is, 50 cents for every $1 change inthe futures price.

As the price moves above the STRIKE PRICE, the DELTA value willincrease to nearly 1.0, at which point the option value changes dollar-for-dollar with the futures price. As the price falls away from the STRIKE PRICE,the DELTA will decrease towards zero. When the futures price is way belowthe STRIKE PRICE, the option will be nearly worthless, and changes in thefutures price will cause very little change in the options tiny remaining value,thus the DELTA will be close to zero. The exact conguration of the curvedepends on the VOLATILITY of the market, and the time remaining untilEXPIRATION of the option. But it will always have this S shape, with the

DELTA value of 0.50 occurring at the STRIKE PRICE of the option.


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CALCULATING DELTA THE EASY WAY

To calculate the DELTA of an option, we need to have the futures andoption prices from two different days. Take the current issue of The WallStreet Journal or Investors Business Daily and an issue from one or twodays before. Find the options and futures prices in each. Calculate [a] thechange in the option price between the two days by subtracting the rst pricefrom the second. Do the same for the futures, subtracting the rst price from

the second, to nd [b] the change in the futures price. (See Figure 1.)

Now divide [a], the change in the option price, by [b] the change in thefutures price. The result is the DELTA. You will nd that with practice, youcan easily do this simple calculation in your head or on paper in just a fewseconds.


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DELTA OPTIONS TRADING

We started out by saying that every time we invest, our goal is tomaximize our chance of making a prot while carefully limiting our risk. Theproblem with futures trading is that the risk can be unlimited. If prices go up,

we make money (if were long), but if they go down, we lose money at thesame rate! What if we could design a strategy that allowed us to make three,four or ve times as much money when prices do go our way, and strictlylimit our risk to a smaller amount if they go against us? Sounds like a goodway of doing things, doesnt it? Well, that is exactly what DELTA OPTIONStrading does! And that is why we have spent so much time explaining detailsup to this point.

Suppose, again, that we think the price of Gold is about to go up. Letsexamine how we can use a DELTA OPTION trade to maximize our prots,and compare the DELTA strategy to simply buying a futures contract.Consider this situation: It is January, and there is increasing internationalunrest, we expect new problems in the Persian Gulf, and we think that anymore inationary news will push the price of Gold substantially higher inthe next few weeks. We have $2,000 to risk, and want to establish a longposition in Gold. The price of Gold is currently $480 an ounce. The marginin Gold is about $2,000 per contract, so we could buy one Gold contract and

use our risk capital to meet the margin requirements of this position. We buyone Gold futures contract at $480, and deposit our $2,000 as margin.

In the next few weeks the price of Gold takes off and moves rapidlyhigher. The price reaches $540 an ounce, and we sell our Gold contract. Ourprot is $60 an ounce on 100 ounces, the size of the futures contract. Ourtotal prot is $6,000. Not bad.

But suppose prices went the other way. There was peace in the

Persian Gulf, inationary expectations died, and the price of Gold crasheddownward. Every dollar that the price of Gold moves down costs us $100.When the price of Gold reaches $470 an ounce, we will have lost $1000.Your brokerage rm will demand that additional margin be deposited. Theprice nally moves down to $420, we run out of money for further margindeposits, and exit the position. Our total loss is $6,000. Terrible.

What would have happened with a DELTA OPTION trade instead? It isagain January, and we want to establish that long Gold position. We have


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$2,000 to risk, and decide to try a DELTA OPTION trade. Instead of usingour money as margin for a futures contract, we will buy several Gold options.The idea of a DELTA OPTION trade is to purchase several PUT (or CALL)options so that the combined DELTA of the options we buy is about 1.0.If the options we choose to buy have a DELTA of 0.25, we would buy four

options. Why four?

Each option will initially increase in value 25 cents for every dollarincrease in the futures price that is what a DELTA of 0.25 means. The totalDELTA of an option position is calculated by adding the DELTAS of all theoptions together. In this case, the total DELTA of the position equals the sumof the four individual option DELTAS, 0.25 + 0.25 + 0.25 + 0.25 = 1. Sincewe own four options, we will make 25 cents on each option when the price ofGold increases $1. With our total position of four options, we will make $1 for

every $1 moved in Gold. The DELTA of our total position will initially be 1.

HOW TO MAKE THREE TIMES MORE MONEY

Back to our example. Gold is trading at $480, and the April CALL optionswith a 500 STRIKE PRICE have a PREMIUM of $4.50 an ounce, or $450per option ($4.50 per ounce x 100 ounces = $450). We examine the lasttwo days prices on The Wall Street Journal, and calculate that the DELTA

of this April 500 Gold CALL option is 0.25 (its PREMIUM has been changing25 cents for every dollar change in Gold prices). With our $2,000 we buyfour options, at a total cost of $1,800, and save the $200 change. The totalDELTA of our position is 1. We will initially make one dollar for every dollarchange in the price of Gold. (For the technically advanced student only:These following calculations are made with a market VOLATILITY of 15%,interest rates at 6%, and 60 days until EXPIRATION but dont worry aboutthese technical comments.)

The price of Gold begins to move up, as we hoped. It quickly reaches$490 an ounce lets say this happens in the next two weeks and our optionsnow have 45 days until EXPIRATION. As the price moves up, rememberthe DELTA of our options is also increasing. At $490, the DELTA on each ofour options has increased to 0.35. We own four options, so the total DELTAof our position is 1.40 (4 x 0.35 = 1.40).Now for every dollar increase in theprice of Gold, we will be making $1.40 on our option position!! And whathappens when the price hits $500 an ounce, the STRIKE PRICE of our


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options? The DELTA on each option is now 0.5, and the total DELTA of ourposition is 2 (4 x 0.5 = 2.0). We are now making $2 for every $1 increasein the price of Gold, or twice as much as we would make had we bought afutures contract!

As the price of Gold continues to rise, we make more and more for eachdollar move as the DELTA of our options increases. If the price reaches$540, the DELTA of each option will be over 0.90, and our total positionDELTA will be 3.6. We will be making $3.60 for every $1 increase in theprice of Gold now we own the prot power of four-hundred ounces of Gold,instead of the single one-hundred ounce futures contract we might havebeen able to purchase using our original $2,000 as margin!

FUTURES VS DELTA OPTIONS POSITION


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EVERY PICTURE TELLS A STORY

Figure 2, above, shows the prot curve for this DELTA OPTIONS trade.The line marked with the + indicates the prot/loss potential of a singlefutures contract. Notice it is a straight line, for every dollar change in the

price of Gold, up or down, there is a $100 prot or loss. When the pricerises from $480 to $540, we make $6,000, or $60 per ounce on 100 ounces.When the price falls to $420, we lose $6,000.

Now notice the prot line of the DELTA OPTIONS trade. It is a curvedline, and a line curved in a very favorable way. As the price goes in thedirection of our trade, we make more and more. When the price movesagainst the trade, downward, we lose incrementally less, until our maximumloss of $1,800 the amount of our original investment is reached. If the price

of Gold moves up to $540, we will make over $14,000, well over twice asmuch as with a single futures contract. When the market drops suddenly,and against our expected projections, we lose a maximum of $1,800, theamount of capital we chose to risk, and far less than we might lose on afutures contract. There is never a chance of a margin CALL. Our risk isdened and totally limited, and our prot potential, depending on how farGold prices move up, is doubled, tripled, or ultimately, nearly quadrupled! Awizard once said that magic is simply power discovered unexpectedly. Here

resides the magic of DELTA: Unexpected and unlimited power to pro t,amazingly allied with total and predictable control of risk. Used in the rightway at the right time, this is a magic that can make futures-trading wizardsrich!

THE COST OF MAGIC

As you must see, this is a most powerful tool. Unfortunately, there is nospell that produces gold from lead at least not one that I can share! This

strategy does have a cost, something is given away in return for the power.Before using the DELTA OPTION approach, you must understand this cost.Return to Figure 2 and examine the prot lines again. Can you gure outwhat is given away in return for the power of a DELTA OPTION trade?

Notice that between 465 and 495 the DELTA OPTION prot line is belowthe futures prot line.In our example trade, if Gold prices make a smallmove, say from 480 to 490, with the DELTA OPTION trade we would make aprot of $675. Had we purchased a Gold futures contract instead of a DELTA


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OPTION position, we would have made $1,000 on this small move.

If prices stayed the same, that is, Gold continued to trade at $480 perounce, our futures position would be a break-even venture. We wouldneither make nor lose money (excluding the brokers commission). Our

DELTA gure 2 option position would, however, lose money. As every daypasses, our options with a 500 STRIKE PRICE are losing TIME PREMIUM.Remember, time is money! Indeed, if we held our position all the way untilEXPIRATION of the options, and prices did not move at all from 480, wewould lose our entire investment of $1,800. This is, of course, because our500 strike options are out-of-the-money and will expire worthless.

The cost of a DELTA option position is this: If prices fail to move muchone way or the other, one makes slightly less or loses slightly more than

he or she would with a futures position. There are two clear advantagesof a DELTA option trade: If prices move dramatically in our favor, we makefar more than we would on an outright futures contract; and if prices movestrongly against us, we lose far less.

Understanding these costs, we can design a trading strategy that willuse option DELTAS efciently and protably. This is not the approach totake every time we trade. As with all tools, it must be used properly to workproperly.

WHEN TO USE A DELTA OPTION TRADE

As we see above, a DELTA option position is designed to multiply protsand limit risks in a big market move. When the markets are going nowhere,it is not wise to use this strategy. How do we spot a market that is about tomake a big move? If I had a certain answer to that question, I would be afool to share it. But there are frequently key times when it seems something

big is about to happen. We may not be certain which way the market willmove, but we know something is going to break loose.

Every two or three months a price trend occurs in one of the many futuresmarkets that offers tremendous opportunity for prots. Through the use ofthe DELTA option strategy, those prot opportunities may be amplied whilekeeping the risks limited. No one catches every big move, but with diligenceand study, wizards and with the right tools eventually will nd themselves in


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the right place with the right magic. Lets examine two key events in 1987which would have made any DELTA option trader rich, IF he had usedhis magic at the right time. After reading these, proceed to the workbookexercises at the end and see what you have learned.

A SILVER CROSS

William Jennings Bryan inamed American political rhetoric with thetheme of Silver eighty years ago, and the re is still burning. Nothing, butnothing, moves like Silver. Remember this, because every few years thetheme is repeated again and again, fortunes are made and lost in the tinklingsound of fury of the Silver market.

So in the Spring of 1987, when Silver started to heat up, the wizards wereready. A DELTA option strategy is perfect for this market when it begins toheat up. This is a dangerous market because it has proven its ability to moveboth ways very, very quickly. A DELTA option position perfectly multiplies theupside potential of a breakout and eliminates the risk of a disastrous movedownward. A good trader knows he will be wrong often, but when he is right,he is very right.

As Silver moved to $6.50 an ounce, it appeared a major breakout to

the upside was possible, and a DELTA option position should have beeninitiated. The 700 strike ($7 an ounce) option had a DELTA of 0.35, and threeof them could have been purchased for about $1,700, depending on the daythe position was initiated. The total risk exposure in the position was then$1,700.

In the next three weeks the market went wild. The price of Silver surgedto well over $10 an ounce during three limit moves upward, and the 700strike option was worth over $20,000 on the nal day of the move. Using

the DELTA option strategy suggested, and purchasing three options, ourtotal prot could have been $50,000 to $75,000, depending on the momentwe chose to exit the position!! I know people who did precisely this, exceptsome of them made much more I should add, I also know people who weretoo greedy to take their huge prots, who wanted more, and who now haveonly regrets.

Our total risk was $1,800 OR LESS! In most instances, if the market failsto move, we will be able to exit our position with a loss well less than our


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maximum risk. In fact, this is one of the principles of DELTA OPTION trading:If your position loses half of its value, exit the position and take the loss.Using this loss-limiting technique, our total risk could have been less than$1,000. Our prots were 50 to 75 times this amount! We could have beenwrong twenty or thirty times (assuming we had that amount of money to

invest) before we hit this big move, and still have made a huge prot on ourtotal investment (losses included).

But this was a rare case, you say. WRONG! Every few months a marketmakes a move like this. In many instances in markets less VOLATILE thanSilver, a position can be entered with less than $500 an ounce or $1,000 ofrisk capital. Not every position will pay off, many will result in losses. But withdiligence and skill and maybe a good dose of luck now and then big protscan be pocketed.

THE CRASH OF 1987 (OR, WHY IS THAT MAN SMILING?)

In October, 1987, many people felt the stock market had reached theend of the line. Others felt another right move upward was brewing. Eitherway, it looked like something major was in the wind. The market had madea signicant, but not major, move downward. In the past, these correctionshad all been followed by explosions upward. But now it seemed that a BIG

move downward MIGHT be close at hand.

Hum, time for the wizards hat. What is our tool today, rat teeth, bat wings,or essence of toad blood? Ah, yes, of course! DELTAS! The time is ripe,the broth is bubbling and steaming. Where it will go, nobody truly knowsnot even wizards. But wizards do know the risks and the right tool for themoment. The autumnal equinox has passed, Halloween is coming. It is mid-October, and time for a little DELTA magic. Being by nature pessimists, wegure the stock market has topped out, and we are going to bet it will make

a move downward. We know we could be wrong, and want to limit our riskagainst a dramatic move upward, since we know that, too, is a possibility.Our solution: a DELTA OPTION trade.

The market is trading around 330 on the S&P 500 Index, and the 310PUTS have a DELTA of about 0.25. They can be purchased for $900 each.We could trade the New York Stock Exchange Index futures with a smallercontract size and PREMIUM, but we decide to trade the S&P and risk alarger amount the cauldron is bubbling in an auspicious fashion, and we


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are going to shoot for the big bucks. We take four options, with a combinedDELTA of 1.0.Our risk capital is $3,600. We will risk half of this, and exit theposition if our loss exceeds $1,800.

Black Monday arrives, everyone is in a panic. But we sit in a corner,

wand in hand, with a strange, rather shocked smile on our faces. It seemswe have just made about $40,000 on each of our four S&P 500 options. Our$1,800 risk just made us $160,000! My, oh my, do we smile we can even buythat new sequined wizards cap we have been coveting for our Halloweencostume this year. All the better, we know most of those phony Wall streetWizards will be wearing hocked garbs to the ball. And people are looking atus, asking, why is that man smiling?

Now that is an extraordinary move for the stock market. Moves like this

are not so unusual in Silver, Sugar, Cocoa, Soybeans, Gold, Crude Oil,and many, many other markets which we can now trade with the DELTAOPTIONS strategy. If we would have taken a futures position, we wouldhave made one-fourth the prot on this move, while accepting an unlimitedrisk. Instead, we made four times as much, and fully limited our risk. Magic iswhat you make it. This may just be sleight-of-hand, but it sure can work.

AN IMPORTANT REMINDER

No strategy of trading futures contracts can guarantee prots. To makemoney, one must always accept some risks. By using different investmentand trading strategies, the ratio of possible risk and reward can be variedbut some risk will always remain. You must understand the risks before youundertake any investment. Although DELTA OPTIONS trading limits risk andoffers tremendous opportunity for prots, there is always the risk of loss.

An understanding of this risk is essential. Never risk money that you cannotafford to lose, BECAUSE YOU MAY INDEED LOSE IT!

Now move on to the workbook examples, and check your knowledge. Ifyou have failed to understand any major points, review the manual again.

After completing this course, you are ready to begin paper trading. Tryout your knowledge, practice calculating DELTAS, practice a few DELTAOPTION trades and see how they work out. At this time, if you have notalready done so, you might want to open your trading account with areputable brokerage rm. GOOD TRADING and GOOD LUCK!


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DETAILS, DETAILS - A FEW QUESTIONS & ANSWERS

Q. What market should I trade?

A. Only trade markets with a daily options volume of at least 2000

contracts. Markets that trade less than 2000 options a day are too thin,and it can be difcult to get good price lls on orders. Your broker should beable to help you avoid markets where the volume is too low. There are overa dozen markets, including all the major futures groups, that have this sort ofvolume, and volume is increasing quickly and will soon reach this level in adozen other markets. Look at the volume gures in The Wall Street Journalor Investors Business Daily (personally, I think Investors Business Daily hasbetter futures information. It also includes charts on all the major markets,updated daily).

Q. When should I establish a DELTA option position?

A. There is no easy answer. You must decide when to trade and whatstrategy to use. Rely on all the information you currently use or can obtain.When it appears that a market has strong potential for a major move, that isthe time for a DELTA trade. You will be wrong frequently, but when you areright, prots can be huge.

Q. What STRIKE PRICE should I buy?

A. Calculate the DELTA of the various strikes using the technique youhave learned here. Remember that the option STRIKE PRICE at the currentfutures trading price will have a DELTA of about 0.5. It is best to tradeoptions with a strike between 0.25 and 0.35.

Q. How many options should I buy?

A. That depends on how much you can risk. With a limited pocketbook,it might be best to buy just one. This is not a DELTA trade but it can work.Usually, it is best to buy three or four options with a total DELTA of around1.0, give or take a little.


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Q. How far from EXPIRATION should I buy the options?

A. The closer to EXPIRATION, the faster the options lose time value.This loss of value is particularly fast in the last 20 or 30 days beforeEXPIRATION. However, the closer to EXPIRATION, the cheaper the options

are. Usually it is best to buy options with about 45 to 75 days left beforeEXPIRATION. There are times when you may believe a big move is justaround the corner. In that situation, buying an option with less than thirtydays until EXPIRATION may be cheaper, and end up more protable on apercentage-of-investment basis. Remember, if you are wrong, this optionwill lose value more quickly than one with more time left. As a rule, stick withthe options that have about two months left until EXPIRATION when tradingDELTA OPTION positions.

Q. When should I exit a DELTA option position?

A. Remember the old futures trading adage, Bulls make money, bearsmake money, but pigs just get slaughtered. If your position loses one-half ofits original value, exit the position and take the loss. NEVER hold a positionall the way to EXPIRATION if it is not in-the-money! On the other hand, if aposition is becoming very protable, let it ride a while. But also rememberthat other great gem of wisdom: Most fortunes are lost while trying to makethe last dime. The last dime is NOT WORTH A FORTUNE. Whenever youare holding a prot that makes your blood bubble with greed for more, exitthe market. Let your greed simmer down, and pocket the prots. Put them inthe bank, but a new car with them convert them into something real that youcan see and feel. When paper prots become real things, their true value isbetter appreciated. There is no room for an easy come, easy go philosophyin this business. Prots do not come easily. When they do come, DONOT LET THEM GO! With prots in hand, there will always be another bigopportunity coming.

Q. What more do I need to begin trading DELTA OPTIONS?

A. Start by paper trading. Work on calculating DELTA. Watch two or threemarkets and the results of DELTA trades over a few weeks. While youredoing this, open your account with a brokerage rm, and use a broker whounderstand options. Most brokers will know what an option is, but most donot understand DELTA trading. If they do not understand it, dont trade withthem. Options trading can be complex, and while you are learning, having a


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good broker will help. Look for a broker who can help calculate the DELTAS,and who will help watch the markets with you. Options trading is one area offutures trading where having a knowledgeable broker really helps.

Q. How much money do I need to trade with the DELTA OPTION

strategy?

A. You can start trading with as little as $1,000, but I suggest $2,500 oreven $5,000. This money must be risk capital. Futures and futures optionstrading is highly speculative, and while large prots are possible, so is theloss of your capital. While you may be lucky and make a large prot on yourrst trade, you might also be wrong and lose your money. Never put all ofyour capital into one trade. Limit your risk on any one trade to a quarter orless of your risk capital. Many successful traders make money on only one

out of every four or ve trades; their prots are just much larger than theiraverage losses. To accomplish this, they limit their risks on every trade, andwhen they do make prots, they protect them.

Q. What is the role of a broker when I trade options?

A. It is essential that you use a broker and a brokerage rm thatunderstand options and DELTA OPTION trading. Options are not very wellunderstood by the majority of brokers, no matter what they might claim. Yourbroker should be able to rapidly tell you the DELTA on any option you areinterested in. He should have this information available on a computer in hisofce. While you can calculate this easily, it is easiest and quickest to justask the computer.

Additionally, some brokers charge very high commissions for optiontrades, and some charge a commission both to enter and to exit the position.DO NOT work with a brokerage rm that charges a commission to both

enter and exit an option trade!! In DELTA OPTION trading you will frequentlybe trading more than one contract, and commissions could become veryexpensive. You should pay only a round-turn commission, which meansONE commission to both enter and exit the trade.


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Q. What more do I need to begin trading DELTA OPTIONS?

A. Start by paper trading. Work on calculating DELTA. Watch two or threemarkets and the results of DELTA trades over a few weeks. While youredoing this, open your account with a brokerage rm, and use a broker who

understand options. Most brokers will know what an option is, but most donot understand DELTA trading. If they do not understand it, dont trade withthem. Options trading can be complex, and while you are learning, having agood broker will help. Look for a broker who can help calculate the DELTAS,and who will help watch the markets with you. Options trading is one area offutures trading where having a knowledgeable broker really helps.

Q. How much money do I need to trade with the DELTA OPTION

strategy?

A. You can start trading with as little as $1,000, but I suggest $2,500 oreven $5,000. This money must be risk capital. Futures and futures optionstrading is highly speculative, and while large prots are possible, so is theloss of your capital. While you may be lucky and make a large prot on yourrst trade, you might also be wrong and lose your money. Never put all ofyour capital into one trade. Limit your risk on any one trade to a quarter orless of your risk capital. Many successful traders make money on only oneout of every four or ve trades; their prots are just much larger than theiraverage losses. To accomplish this, they limit their risks on every trade, andwhen they do make prots, they protect them.

Q. What is the role of a broker when I trade options?

A. It is essential that you use a broker and a brokerage rm thatunderstand options and DELTA OPTION trading. Options are not very wellunderstood by the majority of brokers, no matter what they might claim. Your

broker should be able to rapidly tell you the DELTA on any option you areinterested in. He should have this information available on a computer in hisofce. While you can calculate this easily, it is easiest and quickest to justask the computer.

Additionally, some brokers charge very high commissions for optiontrades, and some charge a commission both to enter and to exit the position.DO NOT work with a brokerage rm that charges a commission to bothenter and exit an option trade!! In DELTA OPTION trading you will frequently


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be trading more than one contract, and commissions could become veryexpensive. You should pay only a round-turn commission, which meansONE commission to both enter and exit the trade.

WORKBOOK EXERCISES

Work through each problem before examining the answer.

1.The DELTA of a Gold CALL option is 0.35. If the Gold price increases by$10 per ounce, how much will the PREMIUM of this CALL option increase?

Answer: A DELTA of 0.35 means that for every $1 increase in the Gold

price, there will be a $0.35 increase in the option. If we multiply the DELTAtimes the change in the price of Gold, we will get the expected change in theprice of the option. In this case, multiply the DELTA of 0.35 times the changein the price of Gold, $10, and you will get the answer of $3.50. From a $10increase in the futures price, the PREMIUM of the CALL option with a DELTAof 0.35 should increase $3.50.

2. We are interested in trading a Silver PUT option. We need to calculatethe DELTA for a series of STRIKE PRICES. On September 1, the December

Silver contract is trading at $7 an ounce. The 700 STRIKE PUT is tradingat $0.23 an ounce, and the 675 STRIKE PUT is trading at $0.12 an ounce.On September 2, the December Silver contract is trading at $6.90 an ounce.The 700 STRIKE PUT is trading at $0.28 an ounce, and the 675 strike PUTis trading at $0.15 an ounce. What is the DELTA of the 700 STRIKE PUT?What is the DELTA of the 675 PUT?

Answer: The DELTA is calculated by dividing the change in the optionprice by the change in the futures price. Calculating the DELTA of the 700

STRIKE PUT rst, the change in the option price is 0.28 - 0.23 = 0.05. Thechange in the futures price is 7.00 - 6.90 = 0.10. The DELTA is calculated bydividing 0.05 by 0.10 = 0.50. The DELTA of the 700 STRIKE PUT is 0.50.

For the 675 STRIKE option, the change in the option price is 0.15 - 0.12 =0.03. The change in the futures price is again 7.00 - 6.90 = 0.10. The DELTAis 0.03 / 0.10 = 0.30. The DELTA of the 675 STRIKE PUT is 0.30.


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3. A Swiss Franc PUT option has a DELTA of 0.27. The price of SwissFrancs falls from 68.50 to 68.10. Will the value (PREMIUM) of the PUToption increaser decrease? How much?

Answer: The PREMIUM of the option will increase. This is a PUT option

which means that a fall in price makes it more rise in price will make a CALLoption more valuable. The DELTA of the option is 0.27, and the price changeof the futures contract was 0.40. Multiply the DELTA by the change in thefutures price to get the change in the option PREMIUM: 0.27 x 0.40 = 0.11.The PUT options PREMIUM will increase by 0.11.

4. A Swiss Franc futures contract controls 125,000 Swiss Francs, andevery 1.00 change in the value of the futures or option contract is worth$1,250. What was the dollar value increase in the PREMIUM of the PUT in

question #3?

Answer: The PREMIUM increased by 0.11. A 1.00 move is worth $1,250.Multiply 0.11 x $1,250 and we nd the dollar value of this 0.11 increase is thePREMIUM of $137.50.

5. The June Gold contract price decreased from $486 an ounceyesterday to $480 an ounce today. The 500 STRIKE CALL option PREMIUMdecreased from $5.85 to $4.25 an ounce. What is the DELTA of this CALLoption? There are 100 ounces in each contract. What is the dollar valuechange in the option PREMIUM?

Answer: The DELTA is calculated, again, by dividing the change in optionprice by the change in futures price. The option price change is $1.60 (5.85 -4.25 =1.60). The change in futures price is $6.00 an ounce (486.00 - 480.00= 6.00). Divide 1.60 by 6.00, and we obtain the DELTA, 0.27. Each contractis for 100 ounces, and each $1.00 per ounce change has a dollar value of

$100.00. This $1.60 an ounce change in the PREMIUM of the option has adollar value of $1.60 an ounce x 100 ounces, or $160.

6. June Deutsche Mark futures are trading at 56.50. We want to initiatea long position, and think there will be a substantial increase in the futuresprice. There is an international meeting coming up which is expected tochange currency alignments, and although we think this will result in anincrease in D. Mark values, it is possible that there will be a sudden collapsein prices if the meeting goes badly. This is a perfect opportunity for a DELTA


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OPTION trade. We calculate the DELTA of the 58 strike CALL option to be0.33. We want to buy several CALL options so that the total initial DELTA ofour position is about 1.0. How many CALL options should we buy?

Answer: The answer is three. Each option has DELTA of 0.33. If we buy

three CALLS the total DELTA of the position will be three times 0.33, orabout 1.0. With a DELTA of 1.0, every dollar gain in the futures contract willresult in dollar gain in our total options position (33 cents on each of thethree options).

7. Each of the CALL options in question #6 is selling for $850. How muchwill it cost to establish the total position? What is our maximum risk on thisposition?

Answer: We are buying three options at $850. Our total cost is $2,550.This is also our maximum risk. We can only lose the amount we have risked,nevermore. In practice, we should try to limit our risk to one-half of theamount paid for the position, or about $1,275. If the value of our positionever decreases to this amount, we should exit the position and take the loss.

8. The meeting mentioned in question #6 concludes, and the price of D.Marks moves up rapidly, as we had hoped. The price quickly reaches 58.50,and we calculate that the DELTA of each of our options has now increased to0.60. What is the total DELTA of our position now? For every dollar changein futures contracts, how much will the value of our options position nowchange?

Answer: We have three options, each with a DELTA of 0.60. The totalDELTA of our position is three times 0.60, or 1.80. Every dollar change inthe future swill result in a $1.80 change in the value of our DELTA OPTIONSposition.

9. If prices continue to increase, will the total DELTA of our positioncontinue to increase? What is the maximum value it can reach?

Answer: The DELTA will continue to increase. The maximum DELTA ofany option will be 1.0. This occurs when the option is way in-the-money, thatis when D. Mark prices far exceed the STRIKE PRICE of our options. Themaximum DELTA of our position would be three times 1.0, or 3.0. At thispoint, every one-dollar change in the futures contract value would result in a


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three-dollar change in the value of our options position. We would essentiallyown three futures contracts.

THIS MARKS THE CONCLUSION OF THE COURSE.

Commodity Research Bureau Delta Options Trading Course

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Transcript of Commodity Research Bureau Delta Options Trading Course