You can build a portfolio with Long Stocks or Short Stocks. But if the market sells off, how can you be comfortable with your exposure to the overall market? Or how can you determine the amount of exposure you have to the market at any given time, especially when trading options? When using options, you’ll need to determine the exposure that the total sum of all options have to the overall market, and be comfortable with that number. You can manage all of this by using Delta.
Recall that Delta is a measure of the change in an option’s theoretical value, given a $1 change in the underlying stock value. Suppose you have an option position and the underlying stock moves by a dollar A Delta value will tell you how much the price of the option is expected to change.
The higher the Delta value, the higher the change in the underlying option price. With a positive Delta value, when the stock is up, the position generally gains value and vice versa.
With negative Delta, the position gains value when the stock is down and the position loses value when the stock is up. So a positive Delta means you are bullish on the position, and negative Delta means you are bearish on the underlying stock
Position Delta represents two very important things – Directional Bias and Portfolio Risk. Sum up all the Deltas across all the individual contracts to determine position delta. The turn over number will give you a good approximation of how much money you will make if you are bullish and have a positive Delta. It will also give you a feeling of how much exposure you have if the market sells off. This is very important because, in case you have too much exposure, you can build diversification techniques that can help you minimize that exposure.