Delta Neutral strategies
- Thread starter rajeshn2007
- Start date
Ok 
Delta Neutral Trading - In Layman Terms.
In layman terms, delta neutral trading is the construction of positions that do not react to small changes in the price of the underlying stock. No matter if the underlying stock goes up or down, the position maintains it's value and neither increases nor decreases in price.
In option trading, this is also known as Delta Neutral Hedging.
In order to understand delta neutral trading, you must first learn what is Delta Value and other option greeks. Delta Neutral Trading and Delta Neutral Hedging are excellent strategies made possible only by the use of options, thus enhancing the value of option trading.
Delta Neutral Trading and Delta Neutral Hedging are only for option traders who wants completely no directional risk nor bias. A trader who wants only to protect against downside losses while keeping the profits open for upside gains should use Contract Neutral Hedging instead. A comprehensive understanding of delta neutral trading and delta neutral hedging is also a pre-requisite skill for all market makers.
Delta Neutral Trading - In Layman Terms.
In layman terms, delta neutral trading is the construction of positions that do not react to small changes in the price of the underlying stock. No matter if the underlying stock goes up or down, the position maintains it's value and neither increases nor decreases in price.
In option trading, this is also known as Delta Neutral Hedging.
In order to understand delta neutral trading, you must first learn what is Delta Value and other option greeks. Delta Neutral Trading and Delta Neutral Hedging are excellent strategies made possible only by the use of options, thus enhancing the value of option trading.
Delta Neutral Trading and Delta Neutral Hedging are only for option traders who wants completely no directional risk nor bias. A trader who wants only to protect against downside losses while keeping the profits open for upside gains should use Contract Neutral Hedging instead. A comprehensive understanding of delta neutral trading and delta neutral hedging is also a pre-requisite skill for all market makers.
Delta Neutral Trading - To Make A Profit
Delta Neutral Trading is capable of making a profit without taking any directional risk. This means that a delta neutral trading position can profit when the underlying stock stays stagnant or when the underlying stock rallies or ditches strongly. This is fulfilled in 4 ways :
1. By the bid ask spread of the option.
This is a technique only option trading market makers can execute, which is simply buying at the bid price and immediately selling at the ask price, creating a net delta zero transaction and profiting from the bid/ask spread with no directional risk at all.
2. By time decay.
When a position is delta neutral, having 0 delta value, it is not affected by the underlying stock movements, but it is still affected by time decay as the premium value of the options involved continue to decay. An option trading position can be set up to take advantage of this time decay and one such example is the Short Straddle which profits if the underlying stock remains stagnant or moves up and down insignificantly.
3. By Volatility.
By executing a delta neutral position, one can profit from a change in volatility with no directional risk when the underlying stock moves. This option trading strategy is extremely useful when implied volatility is expected to change drastically soon.
4. 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 option trading strategy is the Long Straddle . This is because a typical delta neutral position is still Gamma positive, which increases position delta in the direction of the move, allowing the position to profit in either direction.
Delta Neutral Trading is capable of making a profit without taking any directional risk. This means that a delta neutral trading position can profit when the underlying stock stays stagnant or when the underlying stock rallies or ditches strongly. This is fulfilled in 4 ways :
1. By the bid ask spread of the option.
This is a technique only option trading market makers can execute, which is simply buying at the bid price and immediately selling at the ask price, creating a net delta zero transaction and profiting from the bid/ask spread with no directional risk at all.
2. By time decay.
When a position is delta neutral, having 0 delta value, it is not affected by the underlying stock movements, but it is still affected by time decay as the premium value of the options involved continue to decay. An option trading position can be set up to take advantage of this time decay and one such example is the Short Straddle which profits if the underlying stock remains stagnant or moves up and down insignificantly.
3. By Volatility.
By executing a delta neutral position, one can profit from a change in volatility with no directional risk when the underlying stock moves. This option trading strategy is extremely useful when implied volatility is expected to change drastically soon.
4. 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 option trading strategy is the Long Straddle . This is because a typical delta neutral position is still Gamma positive, which increases position delta in the direction of the move, allowing the position to profit in either direction.
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Sell Strangle Option Strategy
This strategy involves selling an out-of-the-money call option and an out-of-the-money put option on the same asset with the same expiration date. This strategy differs from the Sell Straddle strategy because the options are not at the same strike price. This provides a different profit/loss curve that is worth checking out.
This gives you a known, but limited gain, but does expose you to unlimited risk, so you must be careful with this position and be confident of your assumptions. It is not suitable for all traders.
With this strategy, your gain is composed of the premium you received for the call and the put, less the commissions.
When we sell a Strangle, the put and call that we sell are normally on over-priced options that are out-of-the- money. We consider doing this after a dramatic move in the market, when we are expecting it to consolidate the move and digest its gains before moving again. Because of the dramatic move that was made, volatility is high, making the options we sell very expensive. Then as the market consolidates, volatility decreases and lowers the price of the options. Decay also works in our favor with this position.
But be ready to buy back one of the options if there is any indication that the market will resume its trend or reverse direction. If it looks like the market will trend up, buy back the call; if it looks like the market will trend down, buy back the put.
It is also important to cover risks and caveats of this strategy.
The risk of this position is unlimited so you must be very careful. Remember that the margin you pay for this position will be higher because you are initiating two option sell transactions.
It is important to analyze your expectations for the underlying asset and for the market before selecting your strategy.
This strategy involves selling an out-of-the-money call option and an out-of-the-money put option on the same asset with the same expiration date. This strategy differs from the Sell Straddle strategy because the options are not at the same strike price. This provides a different profit/loss curve that is worth checking out.
This gives you a known, but limited gain, but does expose you to unlimited risk, so you must be careful with this position and be confident of your assumptions. It is not suitable for all traders.
With this strategy, your gain is composed of the premium you received for the call and the put, less the commissions.
When we sell a Strangle, the put and call that we sell are normally on over-priced options that are out-of-the- money. We consider doing this after a dramatic move in the market, when we are expecting it to consolidate the move and digest its gains before moving again. Because of the dramatic move that was made, volatility is high, making the options we sell very expensive. Then as the market consolidates, volatility decreases and lowers the price of the options. Decay also works in our favor with this position.
But be ready to buy back one of the options if there is any indication that the market will resume its trend or reverse direction. If it looks like the market will trend up, buy back the call; if it looks like the market will trend down, buy back the put.
It is also important to cover risks and caveats of this strategy.
The risk of this position is unlimited so you must be very careful. Remember that the margin you pay for this position will be higher because you are initiating two option sell transactions.
It is important to analyze your expectations for the underlying asset and for the market before selecting your strategy.
The option trading risks pertaining to options buyers are:
1. Risk of losing your entire investment in a relatively short period of time.
2. The risk of losing your entire investment increases as the option goes out of the money (OTM) and as expiration nears.
3. European style options (like nifty options) which do not have secondary markets on which to sell the options prior to expiration can only realise its value upon expiration.
4. Specific exercise provisions of a specific option contract may create risks.
1. Risk of losing your entire investment in a relatively short period of time.
2. The risk of losing your entire investment increases as the option goes out of the money (OTM) and as expiration nears.
3. European style options (like nifty options) which do not have secondary markets on which to sell the options prior to expiration can only realise its value upon expiration.
4. Specific exercise provisions of a specific option contract may create risks.
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