What It Is:
How It Works/Example:
Let's assume you own a call option on Company XYZ stock. If the price of Company XYZ stock increased by $1.00 and the call option increased by $0.80 in the same time period, then the delta is 0.80 ($0.80/$1.00).
Put options work inversely. Since put options lose value as the underlying security increases, delta is a negative number. If a stock increases $1.00, and the put price decreases $0.50, then the put option has a delta of -0.50. Deltas aren't constant and change according to fluctuations in the underlying stock's price, time left on the derivative until expiration, and volatility in the underlying stock.
Why It Matters:
Delta allows derivatives traders to understand what sort of risk/return they can expect from an investment. For instance, if they believe a stock will increase $2.00 per share in the near future, they can buy a call option on the stock. By using the delta calculation, the investor can calculate their potential gain from the stock's move -- important information to know before taking a risk.