This article, written by Travis Rodock, is taken from SFO (APRIL2012 issue)
Delta Neutral Adds up to SuccessWhat is Delta?
Delta is one of the Greeks associated with most common option pricing models. It is the rate of change in an option’s price relative to the change in value of the underlying asset. A call option with a delta of 0.30 or 30% means that for every dollar the underlying asset moves higher or lower, the call option should increase or decrease in value by 30 cents. Call options always have a positive delta. Put options always have a negative delta. The maximum delta is 1.0 for calls and -1.0 for puts.
What Is A Delta Neutral Position?
Delta neutral refers to any strategy in which the sums of the deltas are equal (or close) to zero. The closer a position’s delta is to zero, the less effect small moves in the underlying asset’s price have on the profitability of the trade. This type of positioning is achieved through a mix of options or options and outright contracts. Let’s say an investor buys one futures contract and four put options each with a delta of -0.25. Since outright contracts always have a delta of 1.0 or -1.0, their total position delta would be calculated as: (4 x -0.25) + 1.0 = -1.0 + 1.0 = 0
A delta neutral strategy could be an option for stability in volatile markets. There are two main reasons investors use delta neutral strategies — to profit or hedge. When looking to profit, traders generally attempt to take advantage of time decay, changes in volatility or large price moves. The two most popular strategies for profiting through delta neutral trading are long and short straddles and strangles.