Capturing Profits with Position-Delta Neutral Trading

Discussion in 'Options' started by ASusilovic, Nov 25, 2007.

  1. Most novice option traders fail to understand fully how volatility can impact the price of options and how volatility is best captured and turned into profit. As most beginner traders are buyers of options, they miss out on the chance to profit from declines of high volatility, which can be done by constructing a neutral position delta. This article looks at a delta-neutral approach to trading options that can produce profits from a decline in implied volatility (IV) even without any movement of the underlying.

    Shorting Vega

    The position-delta approach presented here is one that gets short vega when IV is high. Shorting vega with a high IV, gives a neutral-position delta strategy the possibility to profit from a decline in IV, which can occur quickly from extremes levels. Of course, if volatility rises even higher, the position will lose money. As a rule, it is therefore best to establish short vega delta-neutral positions when implied volatility is at levels that are in the 90th percentile ranking (based on six years of past history of implied volatility). This rule will not guarantee a prevention against loses, but it does provide a statistical edge when trading since IV will eventually revert to its historical mean even though it might go higher first. ( Somehow I am recalling an investor letter from a well known QUANTITATIVE Hedge Fund stating this phrase...if I could just remember which hedgefund it has been...???? ):confused:

    The strategy presented below is similar to a reverse calendar spread (a diagonal reverse calendar spread) but has a neutral delta established by first neutralizing gamma and then adjusting the position to delta neutral. (See An Option Strategy for Trading Market to learn how the reverse calendar spread is a good way to capture high levels of implied volatility and turn it into profit.)Remember, though, any significant moves in the underlying will alter the neutrality beyond the ranges specified below (see figure 1). With that said, this approach allows a much greater range of prices of the underlying between which there is an approximate neutrality vis-à-vis delta, which permits the trader to wait for a potential profit from an eventual drop in IV.

    S&P Reverse Diagonal Calendar Spread

    Let's take a look at an example to illustrate our point. Below is the profit/loss function for this strategy. With the Jun S&P 500 futures at 875, I will sell four Sept 875 calls, and buy four Jun 950 calls. The way I choose the strikes is as follows: I sell the at-the-money for the distant-month options and buy a higher strike of the nearer month options that have a matching gamma. In this case, the gamma is near identical for both strikes. I use a four-lot because the position delta for each spread is approximately negative delta, -0.25, which sums to -1.0 if we do it four times.

    With a negative position delta (-1.0), I will now buy a June futures to neutralize this position delta, leaving a near-perfect neutral gamma and neutral delta. Using OptionVue 5 Options Analysis Software, I have created a profit/loss chart to illustrate this strategy.


    Source :
  2. oh , the infamous upper ( 8? 9? 10?) percentile...
    I would like to ask the author of this article how shorting of vols going for him for this stock:

    Select FRE at

    the mid 20th levels volty ( 9th) looked like a good and "secure" entry then