The term represents the sensitivity of an option’s price to a change in the price of the underlying asset. For example, a value of 0.5 indicates that for every one-dollar change in the asset’s price, the option price is expected to change by fifty cents. This metric is a core component in understanding and managing risk associated with options trading and hedging strategies.
Understanding this sensitivity allows traders and portfolio managers to anticipate the potential impact of market movements on their positions. This knowledge aids in constructing hedging strategies, optimizing portfolio allocation, and making informed decisions about buying or selling options contracts. Historically, its calculation has evolved from simple approximations to more sophisticated models incorporating various factors that affect option pricing.