Delta Neutral trading

Discussion in 'Options' started by optiontimeline, Feb 13, 2010.

  1. One common option trading strategy is called Delta Neutral.

    Without getting too deep into the Greeks – the Delta measures the rate of change of option price with respect to changes in the underlying asset's price. ATM call option has an approximate delta of 0.5, where ATM put has about -0.5. The Theta measures the sensitivity of an option value to the passage of time.

    As an example – the current value of SPY 108 call for March 19 is $2.90, and it has a delta of 0.52 and a theta of -0.04. In practice if you buy this naked call its value will roughly gain $0.52 if SPY goes up by $1 and will lose $0.52 if SPY goes down by $1. But in any case this option will lose $0.04 every passing day, no matter what the underlying asset will do.

    Same applies for SPY 108 put – current value is $2.89, delta is -0.48 and theta is -0.04. It will gain or lose $0.48 according to SPY’s movement, but it will roughly lose $0.04 a day no matter what!

    The idea of Delta Neutral trading is to short sell a combination of both calls and puts, trying to keep a delta value of zero. Theoretically, even if the underlying asset will move up or down, the total value of the strategy will remain unchanged, but the seller still gains the theta value since both calls and puts will lose their value with time.

    A warning for the newbies – Delta Neutral trading can be risky if the underlying asset moves sharply to any direction. The value of the written option can rapidly rise and the potential of loss is actually unlimited. This is why you should always protect your short-sold options with farther option which you buy.

    Common strategies which are delta neutral but still protected are Protected Short Straddle and Protected Short Strangle.

    Now suppose you’ve built a delta neutral strategy by short selling some options. The underlying asset stays in a certain point for a day or two, and you gain some money because of the time value. But the underlying asset will not remain there forever, and the question is - how to follow the delta of the strategy and dynamically adjust it to stay around zero?

    Using OptionTimeline's Strategy Builder - - will make things clearer. Once you build a strategy click on the “B&S” button to see the overall delta of the strategy, and all other Black-Scholes calculation results.
  2. donnap


    Delta neutral refers to any strategy that is, well, delta neutral.

    It may be a net short or net long premium position.
  3. NHS


    Theta er not a constant - it will change if other greeks change.
  4. Of course it will. The greeks change constantly as the underlying asset or other greeks change.
    In the example I gave both call & put happened to have the same theta.
  5. i don't understand why you posted this.

    But you have one glaring error, which tells me you are in no position to be offering warnings to anyone.

    Delta neutral strategies don't have to be negative gamma positions.

    They do not necessarily involve options 'written.'

    Positive gamma positions can be managed with a delta-neutral philosophy. In those situation, your 'warning' is the hoped-for, high profitable result.

  6. If I am not mistaken using B&S on the SPY will not be entirely correct. B&S is intended for dividendless, and European style options. SPY are American and pay dividend options. The exercise style of the option has nothing to do where the option is located.
  7. NHS


    Yes we can only estimate what might happen.
  8. tomk96


    they don't just happen to have the same theta. all calls and their corresponding puts have the same theta. other wise there wouldn't be put call parity.