The delta adjusted notional value is used to show the value of an option. This is different from most other derivatives, which use gross notional value or, in the case of interest rate derivatives, a 10-year bond equivalent value. Investorscan calculate the delta-adjusted notional value of a portfolio by adding the options' weighted deltas together.
The delta adjusted notional value quantifieschanges to a portfolio's value if it was comprised ofunderlyingequity positions, instead of options contracts. For example, a stock is trading at $70 and the delta of the relatedcall option is 0.8. In this case, the value of the weighted delta for the option is $56 ($70 x 0.80).
Key Takeaways
- Investors add options' weighted deltas together to calculate the delta-adjusted notional value.
- Delta refers to the sensitivity of a derivative price to changes.
- To calculate the notional value, multiply units in the contract by the spot price.
Explaining Delta
In derivatives trading terminology, "delta" refers to the sensitivity of the derivative price to changes in the price of the underlying asset.For example, an investor purchases 20 call option contracts on a stock. If the stock goes up by 100% but the value of the contracts only increases by 75%, the delta for the options will be0.75.
Call option deltas are positive, while put option deltas are negative.
Delta measures the changein optionpremiumgeneratedbya change in the underlying security. Delta'svalue ranges from -100 to 0 for puts and 0 to 100 for calls (multiplied by 100 to movethe decimal). Puts generatenegative delta because they havea negative relationshipto the underlying securityi.e.put pricesfall when the underlying risesand vice versa.
On the other hand, call options generate a positive relationship with the underlying security's price. So,if the underlying goes higherso does the call premium, as long as other variables that includeimplied volatility andtime remaining until expiration remain constant.Conversely, if the underlying pricefalls, the call premium will also fall, as long asother variablesremain constant.
Anat-the-moneyoption generatesa deltaof approximately 50, meaningthe option premium will rise or fall by one-halfpoint in reaction toa one-point move up or down in the underlying security. For example, an at-the-money wheat call option has a delta of 0.5,and wheat rallies10 cents. Thepremiumwill increase by approximately 5 cents (0.5 x 10 = 5), or $250 (each cent in premium is worth $50).
Explaining Notional Value andDelta Adjusted Exposure
Notional value is the totalamount of an optioncontract's underlying asset at itsspot price. This term differentiates betweenthe amount of money invested and the amount associated with the whole transaction.
Notional value is calculated by multiplying the units in one contract by the spot price. This is easy to demonstrate with an indexed futures contract. For example, an investor or trader wants to buy one goldfutures contract. Thecontract will costthe buyer 100troy ouncesof gold. If the gold futures contract istrading at $1,300, it then has a notional value of $130,000 (1,300 x100).
Options have a delta-dependent sensitivity sotheir notional value is not as straightforward as an indexed futures contract. Instead, the option's notional value needs to be adjusted based on the sum of exposures withinthe portfolio. The easiest way to calculate this delta adjusted notional value is to calculate the delta for each individual option and add them together.
Notional value is useful in determiningexposure levelsin interest rate swaps,total return swaps,equity options, foreigncurrency exchangederivatives,andexchange traded funds(ETFs).
