Deep In the Money Covered Calls – Very Low Net Delta
I guess I realized this, but just today, it really hit home.
BABA stock has really fallen since I entered the trade. I bought BABA at $86.72 and it is now $84.02. I’ve lost $2.68 per share on those shares.
That is down 3% over the past two weeks! BUT I am still in a net profit on the overall trade.
What is Delta? Delta is a stock market term that reflects how the stock or option that you own is expected to change in price when the “underlying” changes in price. For instance, shares of a company are, by definition, 100 deltas. But an option on those shares is usually less than that. For instance, an “at the money” option on a stock, with little time til expiry, is usually around 50 deltas. The farther out of the money you go, the lower the delta. And the farther in the money you go, the higher the delta. A really deep-in-the-money stock option, such as the one that I own, can be up to 100 deltas.
I bought 100 deltas when I bought the shares but sold 95 deltas in deep-in-the-money calls. So I am only long 5 deltas net.
This means, that when the stock moves $1, I only gain or lose 5 cents. So the stock fell $2.68 over the past two weeks and I probably lost only around $0.12 in intrinsic value on the overall trade.
But the trade I entered had over $1 in “extrinsic” value, which I am earning every day. I earn 3 cents per day in “Theta.” And so over 15 days, I would be expected to gain around 45 cents in the loss of value of the options. So if I lost 12 cents in intrinsic value, I gained 45 cents in intrinsic value over the same time period.
That’s a powerful realization.
