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Understanding "Delta" The Marketing Term

05/30/2014 @ 2:06pm

A basic understanding of marketing tools is critical for any farmer. Options should be at the top of the list. Often, options are misunderstood and not used properly. One element of an option is called delta. Delta is simply a fraction; it explains the change in option value when there is a change to the price of the underlying futures contract. As an example, if the futures moves 10 cents and option changes value by 5 cents, the delta is 5 divided by 10, or 50%.

Buyers of options who do not understand delta may be disappointed when their option is not changing value as fast as they think it should. In most of these cases, this is the basic misunderstanding of delta and expectations. For example, if December corn futures are trading at $5.00 and you purchased a $5.00 put or call, you can't expect this option to begin to move penny for penny with futures. The only exception is when the option is at, or at least very near, to its expiration date and is in the money.

The delta for an at-the-money put option is 50%. Therefore, if corn prices were to drop to $4.50, the option will gain half of the drop ($.25). In fact, the option will gain a little more than $.25 as delta becomes a higher number. In this example, the put would become what is termed deeper in-the-money. As an option becomes deeper in-the-money, delta increases. Therefore, a $.50 drop in corn futures would actually reflect an increasing delta (if bought when at the money) and an increasing rate of change in delta.

So how can you calculate the value of your option? From the date of purchase until expiration, there is a certain time window. Over time, delta for at-the-money or out-of-the-money options begins to slowly decline simply because there is less time or chance for the option to gain value. The easiest method to try and determine your option value is to look at the expiration date and determine where, in fact, your option is relative to futures. In our above example, your breakeven cost at expiration date is the strike price ($5.00) less $.35, or $4.65. Futures below $4.65 would represent a return above the cost. (Note: We are using no commission and/or fees in the example.) Prior to expiration, by using delta, you will have a high level of confidence in how your option will change in value for a give change in futures.

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