Why Dollar Delta Will Change Your Trading

Most serious traders probably have a pretty good grasp of delta.

However, there is one metric related to delta that I use religiously in my trading and that is Dollar Delta.
 

What is Dollar Delta?

Dollar Delta is quite simply the position delta x the underlying price.

We know that delta gives us the share equivalency ratio, so if we own a long call with delta 0.40 it is equivalent to being long 40 shares of the underlying.

Let’s assume the stock is trading at $100. The delta dollars figure would be 40 x $100 = $4,000.

This tells us that the option position is equivalent to having $4,000 invested in the stock.

The delta dollars figure is going to depend a lot on the price of the stock. Let’s say that instead of the stock trading at $100, it was trading at $500. Our delta dollars figure in this example would be 40 x $500 = $20,000.

Perhaps now you can understand why it’s important to look at the delta dollars number and not just the delta.

Dollar delta can help investors determine their exposures to a market move in either direction. To that end, an investor sums the delta for each asset and then multiply the delta by the asset price. Then, all dollar deltas are added together. For example, consider a portfolio of two shares of stock, company ABC and company XYZ:
 

Why Delta Dollar is important

Dollar Delta tells us our overall directional exposure in the market.

If our account size is $50,000 and out delta is 100, that doesn’t really tell us much.

But if our delta dollars exposure is $200,000 then we know that it is too high for our account size.

Personally, I like to set a rule that I don’t let my delta dollar exposure get above 150% of my account size. More conservative traders might like to set that rule at 100%, whereas more aggressive traders might set it at 200%.

It’s personal preference, but the first step as a delta neutral trader is to start paying attention to delta dollars and then develop rules around this metric.

I also have rules regarding the delta dollar exposure for each trade and strategy.

Delta Dollar: Practical example

For an iron condor, I usually set a 200% rule for Dollar Delta.

Assume you have an iron condor on RUT that is risking $20,000. If the Delta Dollars figure gets above plus or minus $40,000 you might want to think about adjusting and getting back closer to neutral.

Conclusion

Delta Dollars is a little known, but very important metric when it comes to option trading. Interactive Brokers provides this information as part of their Risk Navigator.

For traders using other platforms, it is very easy to calculate this number yourself. Just take the overall position delta and multiply it by the underlying stock or index price.

For delta neutral traders, it is important to not let the Delta Dollars exposure get too far away from neutral and rules can be created about when to adjust a position depending on trade size and account size.

About the author: Gavin has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. He likes to focus on short volatility strategies. Gavin has written 5 books on options trading, 3 of which were bestsellers. You can read more from Gavin at Options Trading IQ.