Delta neutral strategies are options strategies that are designed to create positions that aren’t likely to be affected by small movements in the price of a security. This is achieved by ensuring that the overall delta value of a position is as close to zero as possible. Before moving forward click here for a quick overview of the options greeks.
Why do delta neutral trading?
How many times have you been in a situation wherein you take a trade after much conviction, either long or short, and right after you initiate the trade the market moves just the other way round? All your strategy, planning, efforts, and capital go for a toss.
Delta neutral traders essentially want no directional risk. This means these traders are betting on other factors that affect options prices such as time decay and changes in implied volatility.
How to make a profit using delta neutral trading?
In delta neutral trading you are planning to keep the delta of options to 0. This means you need to profit from other factors the options price depends upon.
- By the time decay
When a position is delta neutral, it is not affected by small movements made by the underlying stock, but it is still affected by time decay as the premium value of the options involved continues to decay. An options trading position can be set up to take advantage of this time decay safely without taking a significant directional risk and one such example is the Short Straddle options strategy which profits if the underlying stock remains stagnant or moves up and down insignificantly.
- By Volatility
By executing a delta neutral position, one can profit from a change in volatility without taking a significant directional risk. This options trading strategy is extremely useful when implied volatility is expected to change drastically soon.
- By creating volatile option trading strategies
Even though delta neutral positions are not affected by small changes in the underlying stock, it can still profit from large, significant moves. One example of such an options trading strategy is the famous Long Straddle. This is because a typical delta neutral position is still Gamma positive. The gamma increases position delta in the direction of the move, allowing the position to gradually profit in either direction.
Delta Neutral Hedging
Delta Neutral Hedging is an options trading technique used to protect a position from short term price swings. The advantage of using delta neutral hedging is that it not only protects your position from small price changes during times of uncertainty such as near resistance or support levels, but it also enables your position to continue to profit from that point onwards if the stock rises or falls strongly.
Imagine you have 100 shares of a company stock trading at $ 200. After your analyses, you feel the fundamentals of the company are strong and the price will increase in the long run but may fall in the short run. You can create a delta neutral position and insure yourself against any potential losses in the short term.
Your delta of the initial position is 100 (as you own 100 shares). You need a position of -100 to make your overall position delta neutral. The simplest way to do this would be to buy 200 at the money put options each with a delta of -0.5.
Overall delta = (100 * 1) + (-0.5 * 200) = 0
Whether to short call or long put?
One thing to note is we can achieve delta neutral positions by either short call options or long put options as both have negative deltas. However, time decay works in your favor if you short call options but only provides limited downside protection. On the other hand, long put provides unlimited downside protection but the time decay work against you.
• Use the qm_stream_delta function to get the live delta value from marketxls.
• Use the options strategies template and modify the template to your need.
None of the content published on marketxls.com constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein.