For covered call writers and put-sellers, the option Greeks play a major role in our understanding of the risks and value of our option premiums. We know our option premiums consist of intrinsic value (for in-the-money strikes) + time value. Our initial time value returns reflect the time to expiration + the volatility of the underlying security. When comparing option contracts that expire on the same date, the distinguishing factor becomes the implied volatility of the underlying stock or exchange-traded fund. A second factor that interests option-sellers is the probability of an option expiring in-the-money. When an option expires in-the-money, we have maximized our returns for that position, a positive outcome. However, other covered call option sellers may view this as a negative in that exercise may not be a desired outcome. Delta is an option Greek that can be defined in several ways but one popular definition is that it represents the likelihood of an option expiring in-the-money. Delta values run from 0 to 1 for call options and from 0 to (-)1 for put options from the perspective of option buyers. This article will highlight the relationship between implied volatility and Delta. 

 

Definitions

Implied volatility: This is a forecast of the underlying stock’s volatility as implied by the option’s price in the marketplace.

Delta: The percentage likelihood that, upon expiration, the option will expire in-the-money or with intrinsic value. For additional definitions of Delta, click here.

 

The impact implied volatility has on Delta depends on the moneyness of the strike

On page 29 of my E-Book, Option Greeks Analyzed for Retail Investors, I show a chart which reflects the following relationships: 

ITM (in-the-money)strikes

  • Lower volatility results in higher Delta
  • Higher volatility results in lower Delta

OTM (out-of-the-money) strikes

  • Lower volatility results in lower Delta
  • Higher volatility results in higher Delta

ATM (at-the-money) strikes

  • Higher and lower volatility has little impact on Delta

Generic chart showing the relationship of implied volatility and Delta for different strike prices

For a stock trading near $45.00, the Delta statistics would look similar to those in the chart below which shows implied volatilities of 25, 54 and 85.:

covered call writing and the option Greeks

How Changes in Implied Volatility Impacts Delta

 

Key to chart

  • Pink field: IV stats
  • Yellow field: In-the-money strikes
  • Gold field: At-the-money strikes
  • White field: Out-of-the-money strikes

 

Discussion

Whether our goal is for the sold option to expire in-the-money or out-of-the-money, it is important to understand the impact implied volatility will have on Delta or the probability of this outcome. The information presented in this article can be summarized as follows:

  • Higher implied volatility lowers the probability of an ITM strike expiring in-the-money (Delta decreases)
  • Higher implied volatility increases the probability of an OTM strike expiring in-the-money (Delta increases)

 

Upcoming events

Denver Colorado: American Association of Individual Investors

August 18 @ 9:00 am – 12:00 pm

Saturday August 18, 2018

Click for information and registration details

San Francisco Money Show

August 23 @ 10:00 am – 11:00 am

Hilton San Francisco Union Square

1.Thursday August 23rd: 11:30 AM – 12:15 PM

All Stars of Options: How to Select the Best Covered Call Options in Bull and Bear Markets

2. Friday August 23rd: 10:15 AM – 1:15 PM

Masters Class: How to Generate Monthly Cash Flow and Buy a Stock at a Discount Using 2 Low- Risk Option Strategies (covered call writing and selling cash-secured puts)

Click for information

 

Market tone

This week’s economic news of importance:

  • Existing home sales June 5.38 million (as expected)
  • Markit manufacturing PMI flash July 55.5 (55.4 last)
  • Markit services PMI flash July 56.2 (56.5 last)
  • New home sales June 631,000 (660,000 expected)
  • Weekly jobless claims 7/21 217,000 (219,000 expected)
  • Durable goods orders June 1% (3.7% expected)
  • GDP Q2  4.1% (4.2 expected)

THE WEEK AHEAD

Mon July 30th

Tue July 31st

  • Personal incomes June
  • Consumer spending June
  • Core inflation June
  • Case-Shiller home price index
  • Consumer confidence index July

Wed August 1st

  • ADP employment
  • Market manufacturing PMI July
  • ISM manufacturing index July
  • Construction spending June
  • FOMC announcement

Thu August 2nd

  • Weekly jobless claims 7/28
  • Factory orders June

Fri August 3rd

  • Non-farm payrolls July
  • Unemployment rate July
  • Average hourly earnings July
  • Trade deficit June
  • Markit services July
  • ISM non-manufacturing index July

For the week, the S&P 500 moved up by 0.61% for a year-to-date return of 5.43%

Summary

IBD: Market in confirmed uptrend

GMI: 6/6- Bullish signal since market close of July 9, 2018

BCI: Using an equal number of in-the-money and out-of-the-money strikes. 

 

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a neutral tone. In the past six months, the S&P 500 was up 0% while the VIX (13.03) down by 4%.

Wishing you much success,

Alan and the BCI team





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