First, we should begin with a definition of delta. Delta is the amount by which the price of an option changes for every dollar move in the underlying instrument. For example, an at-the-money call option has a delta of 0.
If you were to purchase 2 at-the-money call options, your delta would be 1, and your position would move inline with the underlying. The further in-the-money the call option is, the closer to 1 the delta will be, and the further out-of-the-money the option, the closer the delta will be to 0. Refer to the table below for further details:. The two most common delta neutral trades are short straddle and long straddle. A short straddle involves selling a call and a put at the same strike price and has a payoff diagram as shown below:.
A long straddle involves buying a call and a put at the same strike price and has a payoff diagram as shown below:. These are two common types of delta neutral trades, but I want to talk more about a delta neutral trading strategy that has worked well for me in the past. Basically this strategy involves selling multiple out-of-the-money puts positive delta and selling the underlying stock negative delta in order to get to a delta neutral position.
These are some of the criteria I look for when determining whether to use this trading strategy:. I used this trading strategy on EWZ earlier in So, my return on the trade was 4. This gave me a slight bullish exposure on the trade.
Another point to note is that as the trade came closer to expiry, the delta began to rapidly reduce due to the fact that the options were so far out of the money and that there was little time left. For this reason I completely closed out the short stock position on June 1 st. Below you can see the graph of EWZ before, during and after the trade period.
If you have any questions on this strategy or any other delta neutral trades, please post a comment below. Leave a Reply Cancel reply Your email address will not be published. Comment Name Email Website.More...