26 lines
1.5 KiB
Plaintext
26 lines
1.5 KiB
Plaintext
Delta Neutral
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To be truly direction neutral or direction indifferent means to have a delta
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equal to zero. In other words, there are no immediate gains if the underlying
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moves incrementally higher or lower. This zero-delta method of trading is
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called delta-neutral trading .
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A delta-neutral position can be created from any option position simply
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by trading stock to flatten out the delta. A very basic example of a delta-
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neutral trade is a long at-the-money (ATM) call with short stock.
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Consider a trade in which we buy 20 ATM calls that have a 50 delta and
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sell stock on a delta-neutral ratio.
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Buy 20 50-delta calls (long 1,000 deltas)
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Short 1,000 shares (short 1,000 deltas)
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In this position, we are long 1,000 deltas from the calls (20 × 50) and
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short 1,000 deltas from the short sale of stock. The net delta of the position
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is zero. Therefore, the immediate directional exposure has been eliminated
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from the trade. But intuitively, there are other opportunities for profit or loss
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with this trade.
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The addition of short stock to the calls will affect only the delta, not the
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other greeks. The long calls have positive gamma, negative theta, and
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positive vega. Exhibit 12.1 is a simplified representation of the greeks for
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this trade.
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EXHIBIT 12.1 20-lot delta-neutral long call.
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With delta not an immediate concern, the focus here is on gamma, theta,
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and vega. The +1.15 vega indicates that each one-point change in IV makes
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or loses $115 for this trade. Yet there is more to the volatility story. Each
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day that passes costs the trader $50 in time decay. Holding the position for |