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Trumpification: Time and Volatility effects on Delta - Options Mastery Series Lesson 10

Filed Under Options Mastery Series 

What is Position Delta?
 
The use of options allows a trader to be more than just a directional player in terms of the direction of the underlying. There are two other things that you can trade using options. One is volatility. A second is the passage of time and quite often traders, when trading volatility or time, don’t want to have a Delta. If a trader can’t go Delta neutral, then they never really will be able to isolate trading volatility or time.
 
First, what is Delta neutral? To get a good idea, let’s consider how we incorporate Delta as a hedge ratio. For instance, if I buy 400 shares of XYZ, each share has a Delta of 1 that’s going to give us a total Delta position of plus 400. In order to get Delta neutral, a trader needs to figure out a way of offsetting these 400 long Deltas. You could buy 8 puts with a delta of 50 for each contract (.5 Delta per option share), which would equal negative 400 deltas. This would give a Delta neutral position in that the 400 long Deltas would be offset by the 8 put contracts. Whenever you have a position where your Delta adds up to zero or close (plus or minus ten), you are Delta neutral. So, what does all this mean?
 
Ron Ianieri says: “Typically, a stock trader who’s been trading stock their whole life, the idea of being Delta neutral is tough because they don’t understand how they’re going to make money. How am I going to make money? If I’m not playing the stock going up or going down, how am I going to make money?” That is one of the beautiful things about options; the ability to make money in more than one way. It’s much more sophisticated than stock. It gives a trader many more opportunities than stock. The idea of a position being able to become Delta neutral allows us to eliminate the Delta factor from our position. At that moment in time, we now can isolate price and only trade volatility or only trade time, otherwise the effects of Delta will interfere with these two strategies.
 
Trumpification
Trumpification is a Delta affect where time and/or volatility create an affect where the in-the-money options increase their Deltas as time passes or as volatility decreases and the out-of-the-money options lose Delta as time passes and volatility decreases.
 
Trumpification is affected by two things; decrease in volatility or the passage of time. We know that in-the-money options have their Deltas increase as the option gets closer to expiration. Out-of-the-money options decrease in Delta as time goes by and/or volatility decreases.
 
Time affects the Deltas of in-the-money options and Delta increases as time goes on. Why? Because options are in-the-money now and with even less time to go they will be even further in-the-money because there will be even less of a chance for them to fall out which means there is more of a chance for them to stay in; thus a higher Delta. 
 
Volatility is defined as the more an option moves, the better chance of that stock doing something to make an in-the-money option out-of-the-money. This is the reverse of the effects of time on Delta; higher volatility means lower Delta. As Ron Ianieri describes it in his Options Mastery Course (www.optionsuniversity.com), “with the volatility at 70 this stock is flapping around so much that there is now a higher percentage chance of this option making its way to being in-the-money. Because of the wild gyrations of the stock it’s got a better chance thus a higher Delta. If the stock is not moving as much the stock is probably not going to run up high enough to get this option in-the-money. If that’s true, then this option has less of a chance of becoming in-the-money when volatility decreases. Because it has less of a chance of being in-the-money its Delta must be lower. I know this sounds confusing, but read it over again and try to visualize what happens.

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