Reading Natenberg now and he seems to imply (without specifically stating) that delta neutral trading is a more successful strategy than directional trading. Do you agree? Do you use both strategies simultaneously? I will venture into delta hedging soon and would love to get some advice from you guys. What do I need to be aware of if I mix the two?
I prefer direction. If you start delta hedging, you need to trade bigger to get the pnl satisfaction on your account size. This leads to less diversification and requires more precision as you are trading a more intricate portion of the option pnl curve.
If you nudge your position towards neutral delta during the trade, you'll end up leaning directionally as you add positions, so in effect you're mixing both strategies. If short gamma, you're adding into the trend. If long gamma, you'll be taking a contrarian opinion with the adds.
It would seem to me that saying a delta neutral strategy is more successful is kind of vague. The actual situation that is going on with what you are trading should determine if delta a neutral strategy is suitable. In my opinion if you are delta neutral in a long straddle way because you anticipate a breakout but not sure of the direction that is probably the stupidest thing you can do because it would be way more effective to wait for the breakout and trade it directionally. If you are delta neutral in a short strangle way because you anticipate consolidation than yes that is the most effective thing to do. So my answer would be you have to do both to be successful. You are making way to much work for yourself if you are just trying to apply a blanket strategy to the instrument you are determined to trade.
In options, you have three choices - you can trade direction, you can trade terminal distribution or you can trade volatility in the risk-neutral setting. I do the last two and leave the pure directional trading to people who can call direction better.
Natenberg was written a real long time ago ... things used to be different then, if you had the (huge) edge of the spread, delta-neutral was the way to go ... times have changed with penny-spreads ... being delta-neutral nowadays has become much harder ... some manage to do well still with delta-neutral, I am not one of them ... I simply stopped doing options like 7 years ago ...
I think delta neutral is easier now because markets have smaller spreads. The issue is that with all the global market makers using FIX connections direct the the exchanges, the markets are too efficient. It's less likely that IVols in an index or underlying will provide excess returns from buy "low" vol and selling 'high" vol, since too many people can monitor the relationships that caused this in the past.
yes, it's 'easier to do', but harder to make decent money ... ;-). If you were a market maker in the eighties or nineties options were a real free lunch if you knew what you were doing by being deltaneutral.