Option Charm
Option Charm indicates how much the delta will change as one trading day passes. Charm is more commonly referred to as "Delta Decay".
The above diagram illustrates the effect of option charm on the delta of an option. The diagram shows option delta across a series of strike prices calculated at 3 different points in time. Notice how the delta of an ITM call option approaches 1 as the option approaches expiration? And that the OTM call options approach 0 as the option nears its expiration date?
Because Option Delta is a probability estimate of the options intrinsic value, Charm is especially useful right near the options expiration date. As expiration closes in, the probability of an option that is out of the money expiring in the money decreases rapidly as each trading day passes and the option charm will estimate how much the decay will be.
The type of trader most likely to benefit from the use of option charm are those traders who use options as a hedging tool. A trader that is hedging his/her delta at the close of business may want to consider the delta decay that the portfolio will experience overnight and hence look at the charm of his/her option position.
The change in the delta will be especially evident the day before a stock goes ex-dividend.
All other things being equal, upon market open the next day the delta of the portfolio will differ by this decay. This may actually prevent the trader from over or under hedging.
The Charm value is the same for call and put options and will range in value from -1 to 1.
ITM call options and OTM put options will have positive charm values. Conversely, OTM call options and ITM put options will have negative charm. So, basically, option charm decreases as the strike price increases.
The above is a sample of what you can expect to see from Option Charm values. Notice that for ITM call options and OTM put options show positive charm, while it reverses for OTM calls and ITM puts?
16 Comments
Peter December 9th, 2012 at 4:09pm
Hi optiongeek,
I didn't use a separate formula for Charm: I calculated the delta for today and then delta for tomorrow. The difference between the two is the Charm.
So if you wanted to, you could have a column for delta and then a second column for tomorrow's delta just adding one day to the date for today() should do it.
optiongeek December 7th, 2012 at 8:55am
Hi there, I'm looking for the analytic formula for option charm for some work I'm doing. There's something publish on the wikipedia page (Greeks (finance)) but I'm not sure I trust it. From the diagram above, you do seem to have coded up charm in excel. I looked at the spreadsheet you publish but it doesn't seem to have charm. Is there any chance you could send me the spreadsheet you used to produce the above? Thanks.
Peter August 29th, 2012 at 7:29pm
No, I think it makes sense that ATM charm has the lowest values as the time effect has a greater impact on OTM and ITM options.
Re: Anonymous August 26th, 2012 at 5:26am
If charm is delta decay, wouldn't the ATM options have the highest charm?
ATM charm is zero as delta is kept at 50.
Peter October 12th, 2011 at 7:16pm
If the decay was based on gamma then it would peak for the ATM options as the gamma curve also peaks ATM. However, the behavior for delta is different to gamma and doesn't have the peak in the middle at time to expiration approaches.
For ITM options the delta will increase closer to 1 (-1 for puts) as each day passes and for OTM options they approach 0. Therefore there is no peak in the curve.
Anonymous October 12th, 2011 at 7:35am
If charm is delta decay, wouldn't the ATM options have the highest charm?
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