Thomsett's  Instablog

Send Message
Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT Press); and "Options for... More
My company:
Michael c. thomsett, author
My blog:
Thomsett Options
My book:
Getting Started in Stock Investing and Trading
  • Options Strategy: Delta Neutral Trading 0 comments
    Jan 19, 2013 10:50 AM


    The "delta neutral" usually describes a spread strategy involving a long and a short position - when the combined values of each are at or near zero.

    The term can involve a number of different strategies, but the concept of delta neutrality is always the central theme. Other than spreads, a delta neutral can also consist of an option position and 100 shares of the underlying stock. This creates an "equivalent stock position" or a synthetic (an options-based of stock-and-options position that changes value just like 100 shares of stock). In theory, the delta neutral position eliminates risk on both the long and short side. Realistically, this changes as soon as values begin to move or when implied volatility changes.

    A mistake for options traders who do not want exercise is to open delta neutral spreads with two short options, a call and a put. The "neutrality" of offsetting exercise risk does not eliminate exercise exposure, it only ensures that one side or the other will be in the money before expiration. This may be true even when different strikes are used. For example, when stock is at 43, a trader sells a 45 call and a 40 put. Both options are out of the money, and the exposure is moved above 45 or below 40 by the value of the sold options. This is a fine theory, but what happens when the stock price moves quickly and substantially? One side of the delta neutral position ends up in the money and has to be closed at a loss, rolled forward, or allowed to exercise. Many of the elegant theories of risk-less option positions end up losing a lot of money because conditions change.

    This risk is made even worse with a short straddle. Because both call and put have the same strike, one or the other is always going to be in the money. Unless the exposed side is closed or rolled before exercise occurs, it will be very difficult to make a short straddle profitable. The position is delta neutral if the stock price is near the common strike at expiration. But the delta neutral status only works out well if the stock's price moves exactly to the strike and never evolves above or below. That does not happen in the expensive, real world.

    Delta neutral trading makes more sense when synthetic long or short stock is used. You can eliminate risk even for synthetic short stock (a long put and a short call at the same strike). By owning 100 shares of the underlying, the call becomes a covered call and the synthetic position is made safer. This is an example of a highly conservative delta neutral position. Because the cost of the long put is offset by the premium from the short call, the option cost is close to zero (it may even by a small credit). The market risk in the short call is eliminated through ownership of 100 shares. The call can be closed at a profit as long as stock remains at or below strike. The long put can be closed to offset point-for-point declines in the stock, or exercised to sell stock at the strike. Because the net option cost is virtually zero, there is no need to worry about time decay in the put.

    To gain more perspective on insights to trading observations and specific strategies, I hope you will join me at where I publish many additional articles. I also enter a regular series of daily trades and updates. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site at to learn more.

    I also offer a totally free newsletter subscription if you are interested in a periodic update of news and information and a summary of performance in the virtual portfolio that I manage. Join at Free Newsletter I look forward to having you as a subscriber.

Back To Thomsett's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (0)
Track new comments
Be the first to comment
Full index of posts »
Latest Followers


More »

Latest Comments

Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.