Delta Neutral Trading

A delta neutral position is when two or more positions are used to establish a neutral market position.

A trader can apply a delta neutral position with stock and one or more options, OR two or more different options.  Whatever combination of securities used, the delta of the two securities offset each other so the position has no price risk, at least initially.

In theory, it doesn’t matter in which direction the stock goes, the position is theoretically not exposed to price risk.

However, reality of often different to theory and thank to our good friend gamma, any delta neutral trade will not stay delta neutral for long.

Let’s take a look at an example using an SPY short straddle. With SPY trading at $273.32, we’ll sell some $274 December calls and $274 December puts. Due to skew we have delta of -3 so to get perfectly delta neutral we would buy 3 shares of SPY.

Now, let’s take a look at the same position assuming SPY moves down 1% today. Using Interactive Brokers Custom Scenario tool we can see how the position would look.

In the table above you can see that the position is no longer delta neutral after a 1% move down in the underlying. If that were to occur, delta would jump to +34.

One thing I like to do with short straddles is delta hedge with the underlying stock or ETF. In this case we would sell 34 shares to get back to delta neutral.

There are many delta neutral option strategies and the idea presented here is just one example. Short straddles involve naked options and are not for everyone. Make sure you understand the risks before trading any option strategy.

If you want to learn more about this type of strategy, I put together some detailed examples here.

Trade safe!