Option Delta Volume Example by Market Chameleon

  • What is Option Delta Volume?

    Option delta volume converts option volume to an equivalent stock volume (bought or sold).
  • What is an example of positive delta volume?

    If a customer buys 10 call option contracts for AAPL stock and with a delta of 0.60 (10 x 100 x 0.60 = 600 deltas), then the customer trade has a positive +600 delta, which is the equivalent to getting long 600 shares of AAPL stock. If the same customer then sells a different call option, let's say 5 contracts in AAPL, that has a 0.20 delta, then this trade has a negative -100 delta. So, the net delta for both trades is a positive +500 deltas (600 bought - 100 sold = +500) or equivalent to getting long 500 shares of AAPL.
    NOTE: We aggregate positive deltas for the following trade types:
    • Buying a Call
    • Selling a Put
    • Buying a Call Spread
    • Selling a Credit Put Spread
    NOTE: We aggregate negative deltas for the following trade types:
    • Selling a Call
    • Buying a Put
    • Selling a Call Spread
    • Buying a Put Spread
  • What is the option delta volume on-balance (also referred to as imbalance)?

    This can give us an indication if there is more bullish or bearish pressure from option order flow. If we take the total positive option delta volume and subtract the total negative option delta volume (traded on the day), we will get the net imbalance. If the net imbalance is positive there is more bullish pressure. If the net is negative there is more bearish pressure.
  • Why is option delta volume a better indicator than regular option volume for bullish and bearish pressure?

    Since option contracts have different strikes and expirations, not all option volume is the same. To normalize the volume to directional pressure, we convert the trade volume to option delta volume.
    For example, let's take 2 different trades, each with 10 contracts but on different strikes.

    Trade 1) 10 deep in-the-money call options

    Let's say that you bought 10 AAPL calls well below the stock price for $50. Your position (10 deep in-the-money calls with a 1.00 delta) will change by $1,000 if the stock moves up a dollar and -$1,000 if the stock moves down a dollar. So, a dealer that sells those same 10 contracts would buy 1,000 shares of stock to hedge directional risk.

    Trade 2) 10 out-the-money call options

    Instead, let's say you trade calls in AAPL that are way above the stock price (0.00 delta) for $0.01. This option is not expected to change in price for a $1 move in the stock price. Therefore, the dealer would not buy shares to hedge this option (because if the stock falls $1, the dealer would lose on the stock and the option will remain a penny).
    In this case, the first trade is much more sensitive to a directional move in the stock, even though the volume is the same for both trades. So, the option delta volume is a much better representation of the immediate pressure it creates on the stock.
  • Why is option delta volume a better indicator than $ notional volume for bullish and bearish pressure?

    Option contracts have different strike prices and expirations that impact the notional value of a trade but the notional value is not always a great indicator of bullish and bearish pressure.
    Here is an example:
    You buy 10 contracts that are deep in-the-money for $100 and a different 10 contracts deep in-the-money for $50.
    Even though you paid twice as much for the $100 contract, both options are expected to change by $1 for every dollar move in the stock. If you exercise the options you will get the same amount of shares as well. So, you can see that the notional amount you paid did not make a difference in this situation.
    Now let's take a deep in-the-money call that is $100 and an at-the-money call that is $1. If you buy 1 deep in-the-money call, it will cost $10,000 in notional ($100 x 100 x 1 = $10,000). However, you can buy 100 at-the-money calls for the same price but you have many more contracts ($1 x 100 * 100 = $10,000).
    As you can see, the second situation has a lot more stock under control for the same notional amount traded. By using the option delta volume, you get a better indicator of the bullish and bearish pressure on the stock.