One of the very exciting things about buying and selling options is the opportunities they offer the watchful trader to structure trades with profit potential regardless of market direction. Numerous techniques have now been developed to provide such opportunities, some difficult to perfect and some very simple.
These market neutral trading strategies all depend fundamentally on the delta of an options contract. There will be a lot of math we will cover to acquire a solid grasp on this measurement, but for our purposes listed here is what you need to learn to successfully put it to use in trading:
Delta is a measurement indicating just how much the price tag on the option will move as a percentage of the underlying’s price movement. An ‘at the money’ (meaning the price tag on the underlying stock is very close to the option’s strike price) contract could have a delta of approximately 0.50. In other words, if the stock moves $1.00 up or down, the option will about $0.50.
Observe that since options contracts control an even lot (100 shares) of stock, the delta may also be viewed as a percent of match between the stock and top cbd oil the option contract. For example, running a call option with a delta of.63 should make or lose 63% just as much money as owning 100 shares of the stock would. Another method of considering it: that same call option with a delta of .63 could make or lose just as much money as owning 63 shares of the stock.
How about put options? While call options could have an optimistic delta (meaning the decision will progress when the stock moves up and down when the price tag on the stock moves down), put options could have a poor delta (meaning the put will relocate the OPPOSITE direction of its underlying). Because market neutral trading strategies work by balancing positive and negative deltas, these strategies tend to be referred to as ‘delta neutral’ trading strategies.
One last note about delta: this measurement isn’t static. As the price tag on the underlying stock moves nearer to or further from the strike price of the option, the delta will rise and fall. ‘In the money’ contracts will move with a greater delta, and ‘from the money’ contracts with less delta. This really is vital, and as we’ll see below, using this fact is how we could make money whether the market increases or down.
With this specific information at hand, we can make a simple delta neutral trading system that includes a theoretically unlimited profit potential, while keeping potential loss strictly controlled. We try this by balancing the positive delta of an inventory purchase against the negative delta of a put option (or options).
Calculating the delta for an options contract is really a bit involved, but don’t worry. Every options broker will give you this number, along with various other figures collectively known as the greeks, within their quote system. (If yours doesn’t, get a fresh broker!). With this data, follow these steps to create a delta neutral trade:
You are not limited to just one put option with this; just make sure you purchase enough stock to offset whatever negative delta you have got on with the put purchase. Example: at the time with this writing, the QQQQ ETF is trading just a little over $45. The delta of the 45 put (three months out) is -.45. I could purchase just one put and balance the delta by purchasing 45 shares of the Qs. If I needed a bigger position, I could purchase two puts and 90 shares of Qs, or three puts and 135 shares of the Qs; so long as the ration of 45 shares of stock to 1 put contract is made, you are able to size it appropriately to your portfolio.