By Darrell Martin
Continuing with simplifying the Greeks as they pertain to binary option trading, let’s look at delta and gamma. Delta might be the most well known of the Greeks. Perhaps, not understood, but traders have heard of it. But what is delta? This article will define delta in easy-to-understand English. Understanding the concepts of the Greeks can help you understand how an option changes price. In the Greek alphabet, delta is the fourth letter. In the Greek numerical system, it has a value of four. In the financial markets, delta is the amount the option will decrease or increase in value, for a one-point/dollar move in the underlying market. Delta is how many cents the price of the option will change, for a one-dollar move in the underlying market.
Delta is the percent probability, or assumption, of whether or not the traded binary will expire in the money, if bought and held until expiration. It is important to note the probability model breaks down once the price repeats on another strike, and the percent probability doesn’t work anymore. For example, when looking at the price ladder and seeing that all of the binaries are showing $7.00 offers or $93.00 bids, the percent probability assumption only works when there is a bid and an offer. Then it is an example of the bid and offer taking over.
However, there is no direct delta on a binary option. Why is there no delta on a binary? This is because a binary is a delta of a call option, at the same strike and same expiration. This is evident when looking at the average of a binary’s bid and offer prices, against the delta of a futures option of the same market, with the same expiration and strike. You will see that the mean price of the binary is the same or similar to that of the future option’s delta. A binary option is simply the delta of an underlying market.
Since the binary is the delta of a call option, they can be considered one and the same. You are in essence trading delta, trading a Greek, when trading binaries. However, you do have Gamma when trading binary options. Gamma is the delta of a delta. Since a binary option is in essence the delta of a call option, the Gamma is the delta of the binary. Gamma is how much the delta will change after each one-point move in the underlying market.
For example, if Delta is .50 and Gamma is .10, then when the underlying market moves up $1.00, the new Delta will be .60. If the underlying market moves up another $1.00, the new Delta will be .70. Returning to the original example of Delta being .50, if the underlying market moved down $1.00, the new Delta would be .40. If it moved down another $1.00, Delta would then be .30, etc. However, this is for buying a call option. Reverse if buying a put option.
On a binary option, you can say that gamma is how much the binary changes over a one-point move in the underlying. Less time, the higher the gamma and the faster the rate of change. It is easiest to see this impact when looking at a binary price ladder and see how the price changes between two strikes that have the same expiration. This is the delta/gamma of the binary option.
Take the time to slow down, look at the strike or price ladder and notice how much prices can change over time and between strikes. You can understand the Greeks. You do not need to know all the words, just understand the price movement. Realize the Greeks are a way for traders to explain price movement.
If you understand how the price moves in relation to the binary strike, in relation to when it expires and in relation to upcoming expected movements and news, you will better understand how the binary price moves. You will be better prepared to choose the right binary for the right strategy.
