Tunnel Delta is the first derivative of the fair value of a binary options tunnel. Accordingly, it reflects the change in the underlying price. In simpler terms, it measures how the value of a binary options tunnel responds to movements in the underlying asset’s price.
In binary options trading, metrics are used to predict price movement better. Tunnel delta helps binary options traders make more thoughtful decisions. In this article, you will learn how to interpret tunnel delta correctly and use it profitably for your trading.
Binary Options Tunnel Delta in a nutshell
- Tunnel delta measures how a binary options tunnel’s value changes with shifts in the underlying asset’s price.
- Tunnel delta indicates the likelihood of the underlying price lying between two strikes at expiration.
- Mathematically, it’s the first derivative of an option’s fair value with respect to changes in the underlying asset’s price.
- Implied volatilities affect tunnel delta, with smoother profiles observed when implied volatility is lower.
How is the Delta used?
In general, the Delta is most often used by market makers who want to hedge their directional risk immediately. Nowadays, the majority of options trading software is able to automatically neutralize the Delta of a single trade at the time of execution, as well as an entire portfolio of options if the Delta exceeds a certain threshold.
Besides, Delta allows drawing conclusions about how likely the underlying price lies between two strikes at expiration. Regardless of the change in the underlying asset.
How is the Binary Options Tunnel Delta defined mathematically?
In mathematical terms, Binary Options Tunnel Delta is defined as the first derivative of the option’s fair value concerning changes in the underlying asset’s price. Symbolically, it can be represented as:
Where:
- ΔTunnel: Tunnel Delta
- ΔV: Change in the fair value of the option
- ΔS: Change in the price of the underlying asset
What does Tunnel Delta show when trading Binary Options?
If the tunnel delta for a binary call option is positive, this means that the option price rises if the price of the underlying asset rises, and vice versa. If the tunnel delta is negative for a binary put option, this means that the option price will fall if the price of the underlying asset rises, and vice versa.
How do implied volatilities effect the Tunnel Delta?
Implied volatilities have an impact on the indicator as well. It is noticeable that the profiles are much smoother when the variable is the implied volatility with 5 days to expiration. This strategy is mainly used by hedgers.
However, implied volatilities in the middle of 25% are pretty large for binary options. This results in the binary options and tunnel delta profiles having similar trajectories. Here, the binary options tunnel gamma is low.
Find more articles in my Binary Options Glossary.