Delta Probability: How Accurate is Predictive Value?
Jun 21, 2017
Delta is of one of the most commonly referenced "Greeks" on the tastytrade financial network. Unlike the other Greeks, delta has several common uses in the options trading world.
Today, we are looking more closely at one particular application of an option's delta. Specifically, an option's delta is often used as a proxy for the estimated probability that a given option will finish in-the-money (ITM).
For example, an option with a .40 delta might, therefore, be expected to finish ITM on 40% of occasions. Depending on your approach and strategy, you may be using this facet of delta in some capacity.
If that is the case, recent research presented on an episode of Market Measures may help you optimize your application of delta. Using data from 2005 to present, the Market Measures team backtested SPY to discover the actual percent of time a given option finished ITM, versus the likelihood suggested by an option's delta.
Over that 12-year period, the study incorporated the following parameters:
Used SPY data from 2005 to present
Examined 15, 30, 40, 50 delta calls and puts
Targeted options with 45 days-to-expiration (DTE)
The results of this study are illustrated in the graphic below:
Looking at the table above, a clear trend can be observed in the results. Over this period of time, the actual likelihood of the 15, 30, 40, and 50 delta calls finishing ITM consistently outperformed the figure forecasted by delta.
On the other hand, with regards to puts, the likelihood of the 15, 30, 40, and 50 delta options finishing ITM consistently underperformed the figure forecasted by delta.
Because SPY is significantly higher during the 12-year period examined, the findings from this study aren't necessarily surprising. However, if you are using delta in this capacity, the results may help you tweak your strategy accordingly.
We hope you'll take the time to watch the complete episode of Market Measures focusing on delta and the probability that an option finishes ITM when your schedule allows.
If you have any questions or comments on this topic, please leave one in the space below or reach out directly at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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