Charm

DEFINITION of 'Charm'

Charm is the rate at which the delta of an option or warrant changes over time. Charm refers to the second order derivative of an option's value, once to time and once to price. It is also the derivative of theta, which measures the time decay of an option's value.

BREAKING DOWN 'Charm'

Charm shows how much an option changes each day until expiration. For example, an investor has an out-of-the-money call with a delta of 15% and a normalized charm of 1. As an out-of-the-money option, the odds of expiring in the money need to fall over time. Other things being equal, when the investor looks at the call the next day, he expects it to have a delta of 14%.

Importance of Charm

Charm is relevant for options traders. Because the market closes for two days each weekend, rather than overnight, the charm’s effect is magnified. For example, when the market closes Tuesday at 5 p.m. and reopens Wednesday at 8 a.m., charm has only half of a day. When the market closes Friday at 5 p.m. and reopens Monday at 8 a.m., two and a half days pass without trading the underlying security. Options traders, especially those managing delta-hedged positions, must pay close attention to their charm on Friday as it impacts their options action on Monday.

Say a trader places a delta-hedged call option on Friday with a charm of 1 and 15% delta; he is short 15 lots of the spot product for every 100 calls he owns. By Monday at 8 a.m., the call delta may have decreased to 12.5%; two and a half days have passed multiplied by the charm of 1. The trader’s delta hedge is no longer accurate; he is too short the underlying security. If the spot market opens higher on Monday, the trader has to buy back deltas to cover his position and reestablish a delta-neutral stance. Special attention is needed around a charm’s expiration time, as it may become very dynamic.

Option Positions With Greater Charm Risk

Some portfolios are self-hedging against charm risk. For example, an investor owns a 15% delta call and a -15% delta put. The charm on these options is offset, leaving them charm-neutral. Since charm makes the option delta tend toward zero over time for out-of-the-money options, the call delta falls over time and the put delta rises toward zero. The position is called a strangle because it is a long out-of-the-money call and put.

RELATED TERMS
  1. Delta

    The ratio comparing the change in the price of the underlying ...
  2. Delta Neutral

    A portfolio consisting of positions with offsetting positive ...
  3. Delta Spread

    An options trading strategy where the trader initially establishes ...
  4. Delta Hedging

    An options strategy that aims to reduce (hedge) the risk associated ...
  5. Delta-Gamma Hedging

    An options hedging strategy that combines a delta hedge and a ...
  6. Futures Equivalent

    The number of futures contracts needed to be associated with ...
Related Articles
  1. Trading

    Options Trading Strategies: Understanding Position Delta

    Learn more about the position delta hedge ratio and how it can tell you the number of contracts needed to hedge a position in the underlying asset.
  2. Trading

    How Does Delta Hedging Work?

    Delta hedging is a derivative trading strategy that attempts to reduce -- or eliminate -- the risk caused by price changes in the underlying asset.
  3. Trading

    Using "The Greeks" To Understand Options

    These risk-exposure measurements help traders detect how sensitive a specific trade is to price, volatility and time decay.
  4. Trading

    Measuring Options With the Greeks

    Delta, gamma, theta and vega are “the Greeks,” and they provide a way to measure the sensitivity of an option’s price.
  5. Trading

    Getting To Know The "Greeks"

    Understanding price influences on options positions requires learning about delta, theta, vega and gamma.
  6. Trading

    The Forex Greeks And Strategies

    We look at the different kinds of Greeks and how they can improve your forex trading.
  7. Retirement

    Is Delta Stock Suitable for Your IRA or Roth IRA? (DAL)

    Learn about Delta Airlines and the factors that affect the company's performance. Discover if Delta stock makes an appropriate investment for IRA accounts.
  8. Markets

    Delta Stock to Trade Ex-Dividend Monday (DAL)

    Delta will send its dividend payment on June 1 to shareholders of record as of May 11.
  9. Investing

    Delta's 3 Key Financial Ratios (DAL)

    Learn why a smaller sales growth rate is actually good for an airline company such as Delta to achieve a better operating margin and higher stock valuation.
  10. Trading

    The Ins And Outs Of Selling Options

    Selling options can seem intimidating but with these tips, you can enter the market with confidence.
RELATED FAQS
  1. Why does delta only range from 1 to -1?

    Learn what the option Greek delta is, what affects the value of delta for an option and why the delta of an option can only ... Read Answer >>
  2. How can you use delta to determine how to hedge options?

    Learn what delta is, how to use delta to hedge options and how to maintain a delta-neutral position by delta-hedging options ... Read Answer >>
  3. What are common delta hedging strategies?

    Learn about common delta hedging strategies, including how to make a position in options delta neutral by offsetting risk ... Read Answer >>
  4. What does it mean to say that a straddle is "delta neutral?"

    Learn what the option Greek delta is and what makes a delta-neutral position, and see an example illustrating a delta-neutral ... Read Answer >>
  5. What are the limitations of using delta to hedge options?

    Learn about the delta of an option, how to delta hedge an option position and the limitations of using delta to hedge an ... Read Answer >>
  6. What industries typically use delta hedging techniques?

    Learn what industries use delta hedging techniques for options trading, and understand how delta neutral trading strategies ... Read Answer >>
Hot Definitions
  1. Glass-Steagall Act

    An act the U.S. Congress passed in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment ...
  2. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  3. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  4. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  5. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  6. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
Trading Center