Option Delta Explained

The speaker provides a detailed description of option delta using detailed examples.  He talks about how Delta provides the sensitivity of call option or put option to a change in the price of the underlying security.

Delta can be derived as the slope of the tangent line on the graph which charts the price of the call option againt the price of the underlying security.  As the price of the stock moves further in the money, the steeper the tangent line becomes; hence, delta moves closer to 1.  Conversely, the further out of the money that the stock moves, the less the slope is on the tangent line, thereby lowering delta.  The lower the stock moves, the closer the delta moves towards 0.

He then moves into illustrating the concept of a delta hedge.  Theoretically, at a point in time, it is possible to completely delta hedge your porfolio so you do not suffer any gains or losses.  He uses an example where he is long a stock and short call options to a degree that a delta neutral hedge is created.  The delta neutral hedge is set up to provide the trader with a riskless portfolio as of a moment in time.  Once the price of the stock moves, the trader must rebalance their porfolio to remain at delta neutral. 

Delta hedging can work in favor of the trader when the stock moves for, or against.  For example, in the example where the trader is long stock and short calls, the losses from a move lower in the stock will be nearly offset with the profit from the short calls.  The trader can then rebalance the hedge or cover the options, thereby bringing the net cost of the position down.  Conversely, in the event that the stock moves higher, the stock price appreciation will be offset by the value of the options and the trader will be forced to rebalance to delta neutral by covering some options or buying more stock.