Delta Neutral Trading - Definition
An option position which is relatively insensitive to small price movements of the underlying stock due
to having near zero or zero delta value.
Delta Neutral Trading - Purpose
To make a profit from a change in volatility,
from time decay or an anticipated swing in the market without taking any directional bias.
Delta Neutral Hedging - Purpose
To protect a position from short term price swings while setting it up for future profits as price direction stabilises. Delta Neutral
hedging can also be used to lock in profit on a long term position while allowing it to continue profiting for the long term.
Delta Neutral Trading - Option Only Example
An At The Money (ATM) call option has a delta value of 0.5 and
an ATM put option also has a delta value of -0.5. Buying both the call option and put option results in a delta neutral position with 0 delta value.
0.5 (call option) - 0.5 (put option) = 0 Delta
Buying both the call option and put option at the same strike price is a popular delta neutral option trading strategy, called a
Long Straddle,
profiting when the underlying stock moves up or down significantly.
Delta Neutral Hedging - Option + Stock Example
A share has a delta value of 1 as it's value rises by $1 for every $1 rise in the stock. If you own 100 shares of a stock, you can
attain a delta neutral position by buying 2 contracts of it's at the money put options with delta value of -50 per contract.
100 (delta value of 100 shares) - 100 (2 x 50) = 0 Delta
Any small drop in the price of the shares will be instantly offset by a rise in the value of the put options. Any small rise in the price
of the shares will also be offset by a drop in the value of the put options. This is an extremely popular option trading technique used by
option traders who owns shares, to protect the value of that position when the stock reaches a strong resistance level.
Delta Neutral Trading - Factors
Delta value changes due to
GAMMA value. Gamma value increases the delta of call options
as the underlying stock rises and increases the delta of put options as the underlying stock falls.
Days left to expiration also affects the delta value of out of the money
options. The nearer to expiration, the lower the delta of out of the money options becomes.
Delta Neutral traders may need to continuously reset positions to zero delta due to the above factors. This is known as Dynamic Hedging or Dynamic
Delta Hedging and is definitely a full time option trading technique.
Delta Neutral Trading - Mathematics
Delta Neutral Portfolio = n1D1 + n2D2 = 0
Where D1 = Delta value of the original options. D2 = Delta value of
hedging options. n1 = Amount of original options. n2 = Amount of hedging options.
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Options involve risk and are not suitable for all investors.
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