Explanation:
Delta represents the rate of change of the option's price with respect to changes in the underlying stock's price. For a call option, delta is positive and indicates how much the price of the option is expected to increase for every $1 increase in the price of the underlying stock. This sensitivity to the stock's price is crucial for traders in implementing hedging strategies, as it helps them determine how many shares of the stock they need to buy or sell to neutralize the option's price movement.
A is incorrect because the delta does not represent the probability that the option will be exercised. It merely indicates the option's price sensitivity to the stock's price movements.
C is incorrect because delta does not measure the sensitivity of the option's price to changes in interest rates; that metric is known as rho, which reflects how much the price of an option changes in response to changes in the risk-free interest rate.
D is incorrect because delta does not represent the time decay of the option’s value, which is instead measured by the theta of the option.
Chapter: Binomial Trees Learning objective: Define and calculate delta of a stock option.
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Q.8 In an options trading seminar, an instructor presents a case where a trader buys a European call option on a stock currently priced at $100. The option has a strike price of $100 and expires in one year. Given the stock's volatility and the market conditions, the instructor calculates the delta of the option and uses it to discuss hedging strategies. What does the delta of this call option primarily represent?
A
The probability that the option will be exercised at expiration.
B
The rate of change of the option's price with respect to the stock's price.
C
The sensitivity of the option's price to changes in the risk-free rate of interest.
D
The time decay of the option's value as it approaches expiration.
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