Delta Neutral Options Trading Strategy

Traderji · #1 19th February 2007, 08:39 AM

Delta Neutral Options Trading Strategy

To understand the Delta Neutral Strategy we need to clearly define Delta.

Delta is nothing but a ratio comparing the change in the price of the underlying asset (eg:cash market price of RIL) to the corresponding change in the price of a derivative (eg:F & O price of RIL).

So in the case of Call Options a delta of 0.8 means that for every Rs.1.00 the underlying stock increases, the call option will increase by Rs.0.80.

In the case of Put Options the Delta will be reversed (negative) because as the underlying security increases, the value of the option will decrease. So a put option with a delta of -0.8 will decrease by Rs.0.80 for every Rs.1.00 increase in the underlying price.

An in-the-money call option nears expiration, it will approach a delta of 1.00, and as an in-the-money put option nears expiration, it will approach a delta of -1.00.

So what is Delta Neutral Options Trading Strategy?
The term "Delta Neutral" refers to any strategy where the sum of your deltas is equal to zero. So, for instance, if you buy 10 call options, each having a delta of 0.60 and you also buy 20 put options, each having a delta of -0.30 you have the following:

........(10 .x .0.60) .+ .(20 .x .-0.30) .= .6.00 .+ .-6.00 .= .0

Your position delta (total delta) is zero, which means you are delta neutral.

For more info on how to use the Delta Neutral trading strategy with examples read http://content.icicidirect.com/ULFil...0392312333.asp

indiatrader · #2 19th February 2007, 05:48 PM

Hi Traderji,
Your starting post could have been a little more expansive on the subject. It is my personal experience in the Indian markets that pure delta neutral startegies barely generate returns.You definitely need a BIAS on which to base your strategy upon, i.e buying futures and puts OR selling futures and buying calls.
Rather, if Delta Neutral is used before a major event like budget or company results can be beneficial due to the huge volatility.
Infact in case of INFOSYS it sometimes gives returns on both sides if squared off at oppurtune times.

I eagerly await your views on this...
rgds
indiatrader

Traderji · #3 19th February 2007, 06:00 PM

Quote:

Originally Posted by indiatrader

Hi Traderji,
Your starting post could have been a little more expansive on the subject. It is my personal experience in the Indian markets that pure delta neutral startegies barely generate returns.You definitely need a BIAS on which to base your strategy upon, i.e buying futures and puts OR selling futures and buying calls.
Rather, if Delta Neutral is used before a major event like budget or company results can be beneficial due to the huge volatility.
Infact in case of INFOSYS it sometimes gives returns on both sides if squared off at oppurtune times.

I eagerly await your views on this...
rgds
indiatrader

This thread was in reply to http://www.traderji.com/78282-post40.html

As a rule I do not trade options because of the inefficient way it is set up on the NSE. However if I do I generally prefer to sell out of money calls in a strong downtrend and sell out of money puts in a strong uptrend.

mfire · #4 19th February 2007, 06:12 PM

Quote:

Originally Posted by Traderji

Delta Neutral Options Trading Strategy

To understand the Delta Neutral Strategy we need to clearly define Delta.

Delta is nothing but a ratio comparing the change in the price of the underlying asset (eg:cash market price of RIL) to the corresponding change in the price of a derivative (eg:F & O price of RIL).

So in the case of Call Options a delta of 0.8 means that for every Rs.1.00 the underlying stock increases, the call option will increase by Rs.0.80.

In the case of Put Options the Delta will be reversed (negative) because as the underlying security increases, the value of the option will decrease. So a put option with a delta of -0.8 will decrease by Rs.0.80 for every Rs.1.00 increase in the underlying price.

An in-the-money call option nears expiration, it will approach a delta of 1.00, and as an in-the-money put option nears expiration, it will approach a delta of -1.00.

So what is Delta Neutral Options Trading Strategy?
The term "Delta Neutral" refers to any strategy where the sum of your deltas is equal to zero. So, for instance, if you buy 10 call options, each having a delta of 0.60 and you also buy 20 put options, each having a delta of -0.30 you have the following:

........(10 .x .0.60) .+ .(20 .x .-0.30) .= .6.00 .+ .-6.00 .= .0

Your position delta (total delta) is zero, which means you are delta neutral.

For more info on how to use the Delta Neutral trading strategy with examples read http://content.icicidirect.com/ULFil...0392312333.asp

Traderji
Thank you Traderji for very good explanation. I have been through the link you have given. It has cleared all the doubts about this "Delta Neutral Strategy"
Once again thanks.
Mfire

indiatrader · #5 19th February 2007, 06:28 PM

Hi Traderji,
thanks for the quick answer. However, you have hit the nail on the head when you have said that "I do not trade options because of the inefficient way it is set up on the NSE".
the trick of any advanced option strategy would be to play on this inefficiencies. As inherently and inefficient market would be inefficient or highly inefficient for only a short period of time and then it would swing towards efficiency.
i have seen in practice that options tend to be highly overpriced before the 10th of every month but as expiry nears , they are very much at par with the Black-Scholes model. So the option selling strategies could be used before 10th and the option buying strategies after 10th.
As for your naked option selling strategies, they do involve unlimited risk. More so over, it's success depends upon the view of the trader and how accurate he is. A rapidly falling market could turn around just as quickly and there is no safe mechanism to stop loss options other than buying opposite futures.... ifyou get what I mean.
rgds
indiatrader

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