Submitted by: Gavin McMaster
Delta is the amount by which the price of an option moves for every dollar move in the underlying security. For example, an at-the-money call option which has a delta of 0.50, the option price will increase by $0.50 for every $1 move in the underlying security. If you were to purchase 2 at-the-money call options, your delta would be 1, and your position would move inline with the underlying. Deep in-the-money calls will have a delta close to 1, and deep out-of-the-money the option, calls will have a delta close to 0.
My Favorite Delta Neutral Strategy
Basically this strategy means selling multiple out-of-the-money puts (positive delta) and selling the underlying stock (negative delta) in order to obtain a delta neutral position. This trade can be risky, so you need to ensure you comprehend the trade before attempting it. These are some of the factors I look for when determining whether to use this trading strategy:
* Generally I pick a stock I'm slightly bullish on. The reason being that as underlying stock increases in price, my delta will increase. This is due to the delta on the short stock position remaining at -1 while the delta on my puts will increase. So the best scenario for me is that the stock rises slightly.
* This is also a trade that will benefit from decreasing volatility, so I pick a stock that has high volatility that I think will decrease in volatility over the course of the trade. The other benefit of high volatility stocks is that you receive more income for your out-of-the-money puts. Although, as with everything be aware that the greater the reward, the higher the risk!
* I pick a stock that I know a lot about. Picking a stock that you know little about just because it fits with your option strategy is a recipe for disaster.
* I plan in advance how I will manage the trade and whether I will dynamically hedge the delta. As the underlying security moves, so will my delta so that I am no longer in a delta neutral position. Before I make the beginning trade I will know what I plan to do in this scenario. If I am bullish on the underlying and my delta becomes positive (i.e. I now have a long exposure), I may leave the trade as is because I am happy with a slightly long bias. Otherwise I might short more stock to get my delta back to zero. I would also plan how often I was willing to do this, as commissions will start to add up and eat into my profits.
* This is a fairly risky strategy, so I generally do not use too much of my capital.
In the past, stocks on which i have successfully used this options trading strategy include RIMM and EWZ. For more information on this options trading strategy and other options strategies, please visit Options Trading IQ. This site is aimed to help you learn everythign you need to know about options trading and improve your overall investment IQ.
About the Author: Gavin McMaster
http://optionstradingiq.com
Source: www.isnare.com
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