Market Neutral, Not Delta Neutral Options Trades

by: Condor Options

There are plenty of ways to put on option trades that have a neutral outlook: straddles, strangles, condors, etc.  Whereas stock and futures traders are limited to whatever price action the market gives you, options let you take a view on implied volatility (vega), the passage of time (theta), and the rate of change of the rate of change of the option per unit move in the underlying (gamma).  Okay, that last one isn’t so obvious, but the idea is to enter various spreads that can profit from changes in the non-delta greeks, such that success doesn’t depend solely, or even primarily, on what happens directionally in the underlying.

But being market neutral doesn’t mean being delta neutral.  For one thing, whether you typically trade in 1 or 10 or 100 lot positions, keeping your net beta-weighted deltas perpetually at or near zero would easily become a full-time job in itself.  And the commissions plus slippage of rigorous delta neutralizing would obviously eat up whatever edge you hoped to obtain from the trades. 

Finally, there’s no contradiction in having a broadly neutral outlook over a given timeframe, while also taking or tolerating a small directional bias over a shorter term.  Again, given the impossibility of ever maintaining a perpetually zero delta portfolio, having at least a tiny directional bias seems inevitable.

On a practical level, this isn’t very significant: it’s not hard to determine how much directional risk you’re comfortable with, and given the ever-decreasing transaction costs in the options markets (falling commissions, tightening spreads), you can think about how often to rebalance yourself in terms of days, rather than weeks.

On a theoretical level, is this a problem for the high priests of frictionless, fluid, efficient markets?  Wouldn’t a truly efficient options market allow participants to stay perpetually and absolutely delta neutral, provided they were taking on exposure in other ways?  Just throwing that out there - feedback is welcome.

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