7/25/2019 What is Delta Neutral Trading_ by OptionTradingpedia

http://slidepdf.com/reader/full/what-is-delta-neutral-trading-by-optiontradingpedia 1/8

1/14/2016 What Is Delta Neutral Trading? by OptionTradingpedia.com

http://www.optiontradingpedia.com/delta_neutral_trading.htm 1/8

Languages  : English  | Bahasa Indonesia 

Home  | Define  | Videos  | Answers  |  Quiz  | Download  | Further Reading  | Beginner Course  | About  | Contact

A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z

Home  > Options Basics  > Advanced Options Trading  > Hedging  > Delta Neutral Hedging

Delta Neutral Trading  : Summary  / Simplified Version  / Comprehensive Version   Search

Select Your Language...   Go

Delta Neutral Trading - Definition 

An option position which is relatively insensitive to small price movements of the underlying stock due to having near zero

or zero delta value.

Delta Neutral Trading - In Layman Terms 

In layman terms, delta neutral trading is the construction  of positions that do not react to small changes in the price of the

underlying stock. No matter if the underlying stock goes up or down, the position maintains it's value and neither increases

nor decreases in price. In option trading, this is also known as Delta Neutral Hedging. In order to understand delta neutral

trading, you must first learn what is Delta Value and other option greeks. Delta Neutral Trading and Delta Neutral Hedging

are  excellent strategies  made possible only  by the use of options, thus enhancing the value of option trading.

Probably The Most Accurate Stock Options Picks Ever... 

Profit with Mr. OppiE, author and owner of Optiontradingpedia.com, through

his best personal options picks now! Top trade of 2013 made 170% Profit onMSFT Put Options!

Delta Neutral Trading and Delta Neutral Hedging are only for option traders who wants completely no directional risk nor

bias. Delta neutral hedging not only removes small directional risks but it is also capable of making a profit on an explosive

upside or downside breakout if a position's gamma value  is kept positive. As such, delta neutral hedging is also great for

uncertain stocks that are expected to make huge breakouts in either direction.

Javascript Tree Menu

Optiontradingpedia Explorer

Options Trading

Options Strategies

Please LIKE Us:

22Like   4

Follow Our Updates:

Top 5 Content 

2. List of Options Strategies 

1. Options Glossary 

4. Delta Neutral Trading 

3. What are Options Greeks 

5. Market Makers 

Top 5 Strategies -

Warehouse Operative in Peterborough - Full o...

Competitive - Peterborough

Apply now

Graduate Analyst (no experience required)

£28,000 per annum - Leeds

Apply no w

7/25/2019 What is Delta Neutral Trading_ by OptionTradingpedia

http://slidepdf.com/reader/full/what-is-delta-neutral-trading-by-optiontradingpedia 2/8

1/14/2016 What Is Delta Neutral Trading? by OptionTradingpedia.com

http://www.optiontradingpedia.com/delta_neutral_trading.htm 2/8

Delta Neutral Trading - Terms And Jargon 

An option contract with 0.5 delta value is referred to as having "50 deltas" (each contract represents 100 stocks, so 0.5 x

100 = 50).

100 shares is referred to as having "100 deltas" as each share has a delta value of 1.

 All else equal and disregarding volatility, being long 100 deltas means that if t he

underlying stock moves up by $1, the position gains $100 and if the stock moves down by $1,the position loses $100. A position that is long 50 deltas means that if the underlying stock 

moves up by $1, the position gains $50 and if the stock moves down by $1, the position loses

$50. Being delta neutral or 0 delta, means that the position value neither goes up nor down

with the underlying stock. Understanding delta is therefore the most important fundamental 

option trading knowledge.

There are 2 forms of delta neutral hedging, known as Static Delta Hedging and Dynamic Delta Hedging. Static Delta

Hedging means setting a position to zero delta and then leave it to unwind on its own. Dynamic Delta Hedging is to

continuously resetting the delta of a position to zero.

 

Delta Neutral Trading - Option Only Example 

An At The Money  (ATM) call option  has a delta value of 0.5 and an ATM put option  also has a delta value of -0.5. Buying

both the call option and put option results in a delta neutral position with 0 delta value.

0.5 (call option) - 0.5 (put option) = 0 Delta

Buying both the call option and put option at the same at the money strike price  is a popular delta neutral option trading

strategy, called a Long Straddle, profiting when the underlying stock moves up or down significantly.

Delta Neutral Trading - Option + Stock Example 

A share has a delta value of 1 as it's value rises by $1 for every $1 rise in the stock. If you own 100 shares of a stock, you

can attain a delta neutral position by buying 2 contracts of it's at the money put options with delta value of -50 per

contract.

100 (delta value of 100 shares) - 100 (2 x 50) = 0 Delta

Week 1 December 2015 

1. Risk Reversal  (-)

2. Bull Call Spread  (+1)

2. Deep ITM Covered Call  (-1)

4. Long Call Option  (-)

5. Butterfly Spread  (-)

Latest Updates 

(Jan 13, 2016)

NEW! How Long To Learn Options? 

(Apr 20, 2015)

NEW! Called Away Explained! 

(Sep 22, 2014)

NEW! Walk Limit Order Explained! 

(May 22, 2013)

NEW! Options Greeks Basics! 

(Feb 24, 2014)

ANSWERED! Why Don't Options Have

To Be Traded To Move? 

(Feb 21, 2014)

ANSWERED! Why Did My Call Options

Decline on Positive Earnings? 

(Feb 17, 2014)

ANSWERED! How Does Time Decay

Work in Credit Spreads? 

(Feb 10, 2014)

ANSWERED! Automatic Assignment

Once Strike Price Reached? 

(Jan 10, 2014)

NEW! Double Iron Butterfly Spread! 

(Dec 26, 2013)

IMPROVED! Call Options Tutorial!

7/25/2019 What is Delta Neutral Trading_ by OptionTradingpedia

http://slidepdf.com/reader/full/what-is-delta-neutral-trading-by-optiontradingpedia 3/8

1/14/2016 What Is Delta Neutral Trading? by OptionTradingpedia.com

http://www.optiontradingpedia.com/delta_neutral_trading.htm 3/8

Any small drop in the price of the shares will be instantly offset by a rise in the value of the put options. Any small rise in

the price of the shares will also be offset by a drop in the value of the put options. This is an extremely popular option

trading technique used by option traders who owns shares to protect the value of that position when the stock reaches a

strong resistance level.

This is a good option trading technique for option traders who holds shares for the long

term to hedge against drops along the way.

Delta Neutral Trading - Purpose 

There are 2 purposes for going delta neutral on a position and are favorite option trading techniques of veteran or

institutional option traders. I call them Delta Neutral Trading and Delta Neutral Hedging.

1. Delta Neutral Trading - To Make A Profit  

Delta Neutral Trading is capable of making a profit without taking any directional risk. This means that a delta neutral

trading position can profit when the underlying stock stays stagnant or when the underlying stock rallies or ditches

strongly. This is fulfilled in 4 ways :

1. By the bid ask spread of the option. This is a technique only option trading market makers  can execute, which is simply

buying at the bid price and simultaneously selling at the ask price, creating a net delta zero transaction and profiting fromthe bid/ask spread with no directional risk at all. This is also known as "Scalping".

2. By time decay. When a position is delta neutral, having 0 delta value, it is not affected by small movements made by the

underlying stock, but it is still affected by time decay as the premium  value of the options involved continue to decay. An

option trading position can be set up to take advantage of this time decay and one such example is the Short Straddle

which profits if the underlying stock remains stagnant or moves up and down insignificantly.

3. By Volatility. By executing a delta neutral position, one can profit from a change in volatility with no directional risk when

the underlying stock moves insignificantly. This option trading strategy is extremely useful when implied volatility is

expected to change drastically soon.

4. By creating volatile option trading strategies. Even though delta neutral positions are not affected by small changes in

the underlying stock, it can still profit from large, significant moves. One example of such an option trading strategy is theLong Straddle  which we mentioned above. This is because a typical delta neutral position is still Gamma  positive, which

increases position delta in the direction of the move, allowing the position to profit in either direction.

2. Delta Neutral Hedging - To Protect Position 

Delta Neutral Hedging is an options trading technique used to protect a position from short term price swings. This is

particularly useful for long term stocks or LEAPs option buy and hold strategy. The advantage of using delta neutral hedging

is that it not only protects your position from small price changes during times of uncertainty such as near resistance or

7/25/2019 What is Delta Neutral Trading_ by OptionTradingpedia

http://slidepdf.com/reader/full/what-is-delta-neutral-trading-by-optiontradingpedia 4/8

1/14/2016 What Is Delta Neutral Trading? by OptionTradingpedia.com

http://www.optiontradingpedia.com/delta_neutral_trading.htm 4/8

support levels, but it also enables your position to continue to profit from that point onwards if the stock rises or falls

strongly.

Example of Delta Neutral Hedging For Stocks - 

John owned and held 1000 shares of Microsoft for $27 per share on 14 March 2007. On 14 May, when Microsoft was

trading at $31, John determined that a resistance level has been reached and wanted to perform a delta neutral hedge

against a short term price change while being able to profit should MSFT rally or ditch strongly from this point. John bought

20 contracts of July31put to execute the delta neutral hedge.

1000 (delta of 1000 shares) - 1000 (delta of 20 contracts of at the money put options) = 0 delta

If MSFT rallies strongly from this point onwards, the put options simply expire worthless  while the stocks continue to gain in

value, allowing the position to continue profiting after the cost of the put options has been offset by the rise in the stock

price.

If MSFT ditches from this point onwards, the put options will eventually gain in price faster than the stocks as 20 contracts

represents 2000 stocks of MSFT, allowing the position to profit as long as MSFT continues to fall.

A delta neutral hedging for stocks actually creates a Synthetic Straddle  options trading position.

Example of Delta Neutral Hedging For Options - 

John owned and held 10 contracts of Microsoft's March 2008 LEAPs call option at the strike price of $20 on 14 March 2007

when MSFT was trading at $27. On 14 May, when Microsoft was trading at $31, John determined that a resistance level

has been reached and wanted to perform a delta neutral hedge against a short term price change while being able to profit

should MSFT rally or ditch strongly from this point. Assuming the LEAPs call options has a delta value of 0.8, John bought

16 contracts of July31put to execute the delta neutral hedge.

800 (delta value of LEAPs options) - 800 (delta value of 16 contracts of at the money put options) = 0 delta

If MSFT rallies strongly from this point onwards, the put options simply expire worthless while the LEAPs options continue

to gain in value, allowing the position to continue profiting after the cost of the put options has been offset by the rise in

the LEAPs options.

If MSFT ditches from this point onwards, the 16 put options will eventually gain in price faster than the 10 LEAPs call

options, allowing the position to profit as long as MSFT continues to fall.

Delta Neutral Hedging effectively "Locks In" the profits on your long term position right at the point the delta neutral hedge

is put in place while allows you to continue holding your favorite stock or LEAPs. Without delta neutral hedging, the only

way you can seal in profits is through selling the position. Options positions attain delta neutral through hedging based on a

hedge ratio  of -1.

Delta Neutral Hedging - Step By Step 

7/25/2019 What is Delta Neutral Trading_ by OptionTradingpedia

http://slidepdf.com/reader/full/what-is-delta-neutral-trading-by-optiontradingpedia 5/8

1/14/2016 What Is Delta Neutral Trading? by OptionTradingpedia.com

http://www.optiontradingpedia.com/delta_neutral_trading.htm 5/8

Delta Neutral Hedging : Step 1 - Determine the total delta value of your current position.

If you are holding 100 shares, then you are long 100 deltas. If you are holding options, then you need to

determine the total delta of your options by multiplying the delta value of each option by the number of options.

If you are holding 10 contracts of call options with 0.5 delta each, then your total delta value is 0.5 x 1000 = 500

deltas.

Delta Neutral Hedging : Step 2  - Determine the kind of delta neutral hedge needed.

If your position is long deltas, then you will need negative deltas as hedge and if your position is negative deltas, then you

will need long deltas as hedge.

Long call options / Short Put options = Long deltas

Short  call options / long put options = Negative deltas

If your position is long 100 deltas, you will need to produce short 100 deltas in order to result in zero deltas. You

can do that through selling call options or buying put options.

Delta Neutral Hedging : Step 3  - Determine the total delta value needed to hedge.

After determining what kind of hedge your position needs, you should now work out how many of those hedges you need

by the following formula : (Total Delta Now / 100) / Delta Value Of Chosen Hedge Options

If your position is long 100 deltas, you will need to produce short 100 deltas in order to result in zero deltas.

 Assuming both the at the money call options and put options both have 0.5 delta value.

(100/100) / 0.5 = 2 contracts

You can either buy 2 contracts of put options or sell 2 contracts of call options to perform a delta neutral hedge on

the position.

Delta Neutral Hedging - Short Or Long Options? 

As you have learnt from above, both short call options and long put options produce negative deltas, so what is the

difference between the two in a delta neutral position? Short call options puts time decay in your favor and results in

additional profits should the underlying stock remain stagnant but it's drawback is that the downside protection it offers is

limited to the price of the short call options. If the underlying stock falls more than the cost of the short call options, your

position will start to make a loss. Long put options offers unlimited downside protection and eventually allows the position

to profit should the underlying stock drop significantly but the drawback is time decay, and can result in a small loss due to

7/25/2019 What is Delta Neutral Trading_ by OptionTradingpedia

http://slidepdf.com/reader/full/what-is-delta-neutral-trading-by-optiontradingpedia 6/8

1/14/2016 What Is Delta Neutral Trading? by OptionTradingpedia.com

http://www.optiontradingpedia.com/delta_neutral_trading.htm 6/8

the erosion of premium value should the underlying stock stay stagnant.

Delta Neutral Trading - Factors 

As we all know, the delta value of stock options  changes all the time. Any change in the delta values will affect the delta

neutral status of a delta neutral position. The rate of change of delta value to a change in the underlying stock is governed

by the GAMMA value. Gamma value increases the delta of call options as the underlying stock rises and increases the delta

of put options as the underlying stock falls. It is exactly this gamma effect that allows a delta neutral position to make a

profit no matter if the underlying stock moves up or down strongly. A position can be made to be totally stagnant no

matter how strongly the stock moves if the position is hedged Delta and Gamma neutral.

Days left to expiration also affects the delta value of out of the money options. The nearer to expiration, the lower the delta

of out of the money options becomes.

Delta Neutral Trading - Dynamic Delta Hedging (Dynamic Hedging) 

Delta value in option trading changes all the time due to Gamma value, moving a delta neutral trading position slowly out

of its delta neutral state and into a directional biased state. Even though this behavior allows delta neutral trading positions

to profit in all directions, in a delta neutral position that is created in order to take advantage of volatility  or time decay

without any directional risk, the delta neutral state needs to be continuously maintained and "resetted". This continuous

resetting of an option trading position's delta value to zero is Dynamic Delta Hedging or simply, Dynamic Hedging.

Example of Dynamic Delta Hedging 

John wishes to profit from the premium value of XYZ company's Feb $50 Call options. He summons all his option trading

knowledge and decides to perform a delta neutral hedging to eliminate directional risk while selling the Feb $50 Call options

in order to reap it's premium value  as profit.

XYZ stocks is $50 now. It's Feb $50 Call options is $2.50 ,delta value 0.5, gamma value 0.087 and theta  value -0.077.

:: Here is John's initial delta neutral position :

Long 100 XYZ shares + Short 2 contracts of Feb50Call.

(100 deltas) + (- 0.5 x 200) = 100 - 100 = 0 delta 

John's delta neutral trading position is delta neutral upon execution and will decay at a rate of $15.40 (-0.077 x 200) perday, all else being constant and will eventually make the whole premium value of $500 ($2.50 x 200) as profit.

:: 5 days later, XYZ stock rose by $1 to $51.

XYZ stocks is $51. Feb $50 Call Options is $3.00, delta value 0.587, gamma value 0.083 and theta value -0.075.

The Feb $50 Call option's delta value rose 0.087 due to the gamma value of 0.087 when the position was established.

John's position becomes :

(100 deltas) + (-0.587 x 200) = 100 - 117.4 = -17.4 deltas 

7/25/2019 What is Delta Neutral Trading_ by OptionTradingpedia

http://slidepdf.com/reader/full/what-is-delta-neutral-trading-by-optiontradingpedia 7/8

1/14/2016 What Is Delta Neutral Trading? by OptionTradingpedia.com

http://www.optiontradingpedia.com/delta_neutral_trading.htm 7/8

Perform Delta Neutral Trading With Best Options Broker, OptionsXpress!

This means that from now on, John's position is no longer delta neutral and will lose $17.40 for every $1 rise in the

underlying stock.

:: John performs Dynamic Delta Hedging or Dynamic hedging.

John buys an additional 17 shares of XYZ stocks through his option tradng broker. His position now becomes:

Long 117 XYZ shares + Short 2 contracts of Feb50Call.

(117 deltas) + (-0.587 x 200) = 117 - 117.4 = -0.4 deltas 

Position now is only short 0.4 deltas, which is effectively delta neutral. This is dynamic delta hedging.

As you can see from the above dynamic delta hedging example, such procedure is tedious and requires constant effort and

monitoring. This is why dynamic delta hedging is an option trading technique mostly performed by professional option

traders such as market makers. Again, in order to protect the position from wide swings in the underlying stock in between

the dynamic rebalancing of the delta neutral position, the position can also be constructed to be gamma neutral as well.

Delta Neutral Trading - Mathematics 

Delta Neutral Portfolio = n11  + n22  = 0

Where 1 = Delta value of the original options. 2  = Delta value of hedging options. n1  = Amount of original options. n2  =Amount of hedging options.

 

Continue your journey of discovery...

Click Above For Content Index  

What Is Options Delta?

What Is Hedging?

What Is Gamma Neutral Hedging?

What Is Contract Neutral Hedging?

What Is Hedge Ratio?

What Is Synthetic Straddle?

How Stocks Can Be Riskier Than Options?

What Are Option Trading Risks?

What Are Option Greeks?

Graduate Analyst (no experience required)

£28,000 per annum - Leeds

Apply now

Driver / Installation Assistant

From £15,000 to £16,500 per annum -

Apply now

7/25/2019 What is Delta Neutral Trading_ by OptionTradingpedia

http://slidepdf.com/reader/full/what-is-delta-neutral-trading-by-optiontradingpedia 8/8

1/14/2016 What Is Delta Neutral Trading? by OptionTradingpedia.com

http://www.optiontradingpedia.com/delta_neutral_trading.htm 8/8

Share   |

Questions?  | Suggestions?   What Are Market Makers?

What Are Option Strategies?

Stock Options

Options Trading

Back To Main  | Go To Option Trader's HQ 

Search

Copyright © 2006 - 2016 Masters 'O' Equity Asset Management. All Rights Reserved.

Webmaster: admin@mastersoequity.com. Site run and managed by Masters 'O' Equity Asset Management. Privacy Policy | SiteMap | Advertise

Important Disclaimer  : Options involve risk and are not suitable for all investors. Data and information is provided for informational purposes only, and is not intended for trading purposes. Neither

optiontradingpedia.com, mastersoequity.com nor any of its data or content providers shall be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon. Data is deemed accurate

but is not warranted or guaranteed. optiontradinpedia.com and mastersoequity.com are not a registered broker-dealer and does not endorse or recommend the services of any brokerage company. The brokerage company

you select is solely responsible for its services to you. By accessing, viewing, or using this site in any way, you agree to be bound by the above conditions and disclaimers found on this site.

Copyright Warning  :  All contents and information presented here in optiontradingpedia.com are property of Optiontradingpedia.com and are not to be copied, redistributed or downloaded in any ways unless in

accordance with our quoting policy. We have a comprehensive system to detect plagiarism and will take legal action against any individuals, websites or companies involved. We Take Our Copyright VERY Seriously!

Site Authored by Jason NG aka Mr. OppiE