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Delta and Theta Concepts for the New Options Trader



Welcome to Good Kids Trading!


At GKT, and particularly in our FREE Discord channel, http://www.goodkidstrading.com/join, we talk a lot about Delta and Theta.


“I’m just going to let Theta decay work.”

“I need more positive Deltas so I added this position.”

“You want positive Theta.”

“This strangle has gone out of my comfortable range, I’m rolling one side to neutralize Delta.”


Delta and Theta are both Greek letters and are just two of the main “Greeks” that option traders care about.


In this article we will discuss these two Greeks but on a level that is needed for the new options trader to get a fundamental understanding. Don’t worry, no fancy math here, just the fundamental concepts.


For those who want the quickest possible explanation, here it is:


Delta is Direction


Theta is Time


If you already understand what I mean by that, check out these articles that are a little more advanced...


What is Options Delta?

Delta is direction.


Before we even mention an options contract, let’s talk about simple shares of a stock.

When we own 1 share of a stock, if the stock’s price changes up or down by $1, then we will have made or lost $1. If it went stock goes up or down by $5, $10, or $19.21, then our profit or loss will be exactly the same as the price move.


Simple enough right?

Taking the same concept, imagine if we only buy 30 shares of stock and the stock price goes up $5. We would be up $150. If we bought 100 shares of stock and it goes down $5, we would be losing $500.


None of this should be a new concept if you have ever bought stock before.


Moving to options, each option contract has a Delta that gets calculated by some math formula beyond the scope of this article.

Options chain highlighting Delta

Each options contract has a different Delta. By default, calls have positive Delta and puts have negative Delta.


The easiest way to think about Delta is that the number of the Delta is roughly equivalent to that same number of shares. Looking at the 430 SPY call option as an example, it carries 0.71 Delta, which is roughly equivalent to buying 71 shares of SPY. Remember 1 option contract covers 100 shares of stock, so 0.71 Delta multiplied by 100 shares is 71. The SPY 440 call has 0.50 Delta so roughly equivalent to buying 50 shares of SPY.


Fun fact: The at the money (ATM) options almost always have 0.50 Delta.


Having more Delta is the same concept as buying or selling more shares. Buying 10 shares of a stock would cost less than buying 40 shares, and Delta follows the same trend as you can see from the screenshot above.


But this still doesn’t explain why Delta is direction, so let’s get to that right now.


Positive Delta options gain value as the price goes up. Positive Delta is like buying shares. Negative Delta options LOSE value as the price goes up. Negative Delta is like shorting shares. When you have negative Delta, you want the price to go down.


Regardless of whether your option strategy has one leg,

One legged options trade

or it combines several legs with different numbers of contracts,

Multi-leg options trade

your broker will calculate the total Delta for the position. If it is positive, then you set up a bullish trade. If the Delta is negative, then that is a bearish trade. How bullish or bearish is determined by the size of the Delta.


Hopefully now you understand why Delta is direction.


At GKT we set up bullish, bearish, and neutral trades. Our really bullish trades have large amounts of positive Delta, really bearish trades have large amounts of negative Delta, and neutral trades are close to 0 Delta. The closer to zero the delta is, the more we want the stock to not have any large moves in either direction.


With directionality comes risk. If you are extremely bullish and your options strategy has +80 Delta, this is equivalent to buying 80 shares. If you get the bullish move you want, you will win big. If the stock goes down, you should expect to see a large losing trade on your hands.


Tailor your Delta to match how much or little of a directional move you expect the stock to make.


What is Options Theta?

Theta is time.


Each option contract comes with an expiration date. The number of days to expiration (DTE) reflects how much time is left on the contract.



Notice how when there are 90 DTE the curve is fairly flat. This shows how little of the option's premium is lost over time. Compare that to 21 DTE and 0DTE where the curve rapidly approaches vertical. This shows that a lot of option premium is lost over a very short period of time.


To illustrate this concept, imagine you are some guy named Eric and you wanted to write a blog article. The Head Honcho, let’s call him Justin, says, “Can you get a draft to me in the 60 days?” “No problem!” Eric says.


Well wouldn’t you know it, Eric is a procrastinator. 60 days is forever and a half away to him. Time passes, and 21 days until the article is due. Justin asks, “Hey bro, you know me, no pressure but if you can’t work on this, I’ll roll the idea to someone else.” “No, I’ll get it taken care of,” affirms Eric. After all, 3 weeks is almost forever away, Eric's got plenty of time.


Now it is the week of the article’s deadline and all of the sudden Eric begins feeling the pressure and maybe makes an outline or jots a few thoughts down. Then the day or two before it is due, Eric finally gets going and works away in a frenzied state. In fact, he made final edits and sent the article right at 3:59pm EST, just in the nick of time.


The emotional turmoil Eric experienced is similar to how Theta works.

Like Delta, Theta has a very complex math formula that is beyond our purposes here. Unlike Delta, Theta is always listed as negative for both the calls and the puts.

Options chain highlighting Theta

Theta is always negative because options chains assume you are buying the option. Unfortunately for all of us, time will do nothing but tick away. With each passing moment, the expiration date draws closer and there is less time contributing to the option’s value.


Theta is a procrastinator like Eric.


Have you ever been caught in traffic when you are running late for an appointment? The value of that time is exponentially more valuable when you have 5 minutes to spare compared to when you have 5 hours.


***Insert typical free Theta decay curve***


Time doesn’t carry much value when the deadline remains far away but as the expiration date closes in, that time becomes extremely precious and even more valuable.


At GKT we love having positive Theta. When your trade has positive Theta, this means you make money as time passes. Depending on the type of trade you make, your main goal may even be to profit from the passage of time.


The only way to get positive Theta is to sell an option. When you sell an option, you are selling that time value to someone else. As time passes, which it always will, the time value will go down. The larger the Theta, the larger the influence time has on the option’s price.


As powerful as Theta may seem, it is but one component of an option’s price.


How to Use Theta and Delta

Delta is direction and Theta is time.


Take a look at this example. This is definitely NOT an options strategy. I literally clicked 4 different times on the screen to come up with this trade for the purposes of this example

Complex options trade to highlight Delta and Theta

In the green box, I have boxed in both Delta and Theta. Looking only at these two numbers, answer these questions for me.


1. What direction would I need SPY to move for this trade to be profitable?


2. If SPY’s price doesn’t change but time continues to tick by, would I expect to make money or lose money?


3. What if time passes and SPY increases in price by a large amount, will I be profitable?


Keep in mind this is all theoretical but this mental exercise can and should be done on every options trade you make.


Now that you’ve had a second let’s go over the answers.


1. What direction would I need SPY to move for this trade to be profitable?

This trade has negative Delta. In this trade, I have -118 Delta which is very close to saying I have shorted 118 shares of SPY. Negative Delta trades, and shorting shares, both are profitable when the price goes DOWN.


2. If SPY’s price doesn’t change but time continues to tick by, would I expect to make money or lose money?

This trade has positive 28 Theta. Positive Theta means that, all else being equal, my trade should become more profitable as time passes.


3. What if time passes and SPY increases in price by a large amount, will I be profitable?

This is a "put it all together" type of question and one where the answer becomes more intuitive the more you trade options. As important as Theta is, if you have a directional trade and the price in the opposite direction, Theta will help reduce the loss but that may be about it.


In this trade we have -118 Delta which is an extremely bearish trade. Because we are extremely bearish, if SPY increases in price, we will be directionally incorrect in a big way. 28 Theta isn’t a small amount of Theta but it almost certainly won’t counteract being wrong on the price movement.


Next Steps...

If you have any questions about the concepts in this article, our Discord is full of options traders who are happy to share their thoughts and provide explanation behind the trades. If you are really serious about learning and mastering options, joining in on those real time discussions is the best way to accelerate your learning. http://www.goodkidstrading.com/join


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