Delta And Time To Expiry
Now we will understand Delta with respect to change in Days to Expiry:
An option’s Delta changes as one trading day passes. This is often called “Delta Decay”.As the expiration is nearing, the time value portion of an option is declining. This causes the Delta of ITM options to increase (i.e. ITM option’s Delta gets closer to 1 for Calls or to -1 for Puts) and the Delta of OTM options to decrease (i.e. OTM option’s Delta gets closer to 0).
Assuming the Spot price to be 17500 and volatility at 17%, let us figure out the behavior of ITM, ATM and OTM options and their Deltas.
At The Money Strike 17500
Observations: As days to expiry decreases,
- Both Call and Put premiums decrease.
- ATM option approaches to 0.5 for call and -0.5 for put.
Strike 17000 where call option is ITM and put option is OTM
Here, as the days to expiry decreases,
- ITM Call Option approaches to 1.
- OTM Put option approaches to 0.
Strike 18000 where call option is OTM and Put option is ITM
Again, as we are nearing maturity, or as days to expiry decreases, we see
- OTM Call Option approaches to 0.
- ITM Put option approaches to -1.
One should avoid buying deep OTM options because the Deltas are really small and the underlying has to move by large value to work in favor. However, for the very same reason, selling deep OTM options makes sense (we shall discuss this when we learn Theta).