The Most Important Lesson for Options Traders

2) Starting with a high delta reduces your loss when the stock moves in the wrong direction.

This is what an alarming number of option traders either don't understand, or only have a slight understanding of.

Remember how I said that the delta of a stock option changes as the stock fluctuates? For example, in the table above, you see that the delta of the Jan 20 Call (which is 2.5 points in-the-money) is 0.84. It has such a high delta because it is 2.5 points in-the-money.

But if SGP traded down to $21, the Jan 20 Call would only be one point in-the-money. Thus, the delta would change from 0.84 to 0.69.

This is a good thing if you are the owner of that call option. It means that as SGP stock trades lower, the call option actually loses less in value (dollar-wise) than the stock!

In other words, you stand to lose a lot less by owning the call option. This is especially true when you are talking about an option that has an expiration day farther out than 90 days. (Remember, 90 days before expiration is when the extrinsic value decay tends to speed up.)

NOTE: When you buy an option strictly for the upside (and you aren't using it for hedging purposes), you should always give yourself extra time for it to work. Try to buy it with an expiration month that is at least 90 days after the time that you wish to sell it.

Think about that for a second.

This is the part that many newer option traders tend to overlook, and it's one of the most important considerations when using beginner, intermediate or advanced option strategies.

Buy More Delta, Lose Less if Trade Goes South

When you buy options with a high delta (which are deep in-the-money) and the stock trades lower, your option loses less value than the stock does!

So, you put up less capital (and, therefore, ultimately risk less capital), and the call option holder will actually lose less value when the stock trades down a few points. If SGP traded from $22.50 down 3 points to $19.50, the Jan 20 Call is likely to lose only about $2.30 in value.

So, why even bother trading stock? What if the stock drops by 10 points? You'd only lose a maximum of $3 that you committed to the option as opposed to the $10 that the stockholders lost!

There's more to this, and it gets even better. So go on to Part II of this series where you'll learn how to Turn Your Deltas Into Dollars.