To understand how delta neutral trading works, we first need to grasp what the options delta is. When calculating an options price, we use 5 components called " the greeks " - The delta is one of these 'greeks' and simply put, is an indication of the amount by which an option price is expected to move in proportion to a price movement in the underlying financial instrument such as a company stock.

It is usually expressed as a number to 4 decimal points. Call options always have a positive delta, which may vary from virtually zero to as high as 1. Put options always have a negative delta with the same parameters as calls.

Delta Neutral Trading Options Strategies

When an option 'strike price' is the same as the current stock price, it is called "at the money". At-the-money call and put options theoretically have a delta of 0. But the further in-the-money an option goes, the greater the delta, up to a maximum of 1.

This effectively means that as the option price becomes profitable, it does so at an accelerating rate. We notice the following: We want to hedge our shares against future loss, but also in such a way that we can profit from a rise in share price as well. These two scenarios work on the assumption that the underlying price movements will be in the short term and do not take into account the time decay factor in option pricing.

Nevertheless, all the information you need for delta neutral trading can be obtained from looking at the option chains data on any reputable broker site. Once you understand how delta neutral trading works, why limit yourself to hedging shares? Futures contracts and synthetic stock positions have a 1. You can do the same thing with currency options using the leveraged spot price for forex pairs. The straddle is the classic and most widely known delta neutral option trading strategy.

A straddle is defined by the purchase of an equal number of at-the-money ATM call and put options with the same expiration date. Since ATM options have a delta of around 0. Strangles on the other hand, involve OTM options whose deltas will be much less than 0.

But again, depending on the price of the underlying financial instrument in relation to the option strike prices when you buy, the respective OTM deltas should practically neutralise each other.

Capturing Profits With Position-Delta Neutral Trading

Excellent profits can be made from delta neutral trading using options alone, but you must take other other 'greeks' particularly theta time decay into account when choosing your positions. Once you understand how delta neutral trading really works, you can use it to profit from straddle trades another way.

In our example above, we used the delta to determine how many option contracts we would need to purchase to hedge the shares we own. But we can also do it the other way around. If we start with a straddle in place, we can use the delta for various strike prices to determine how many shares we would need to buy or sell in order to remain delta neutral.

DeltaNeutral - Historical Option Price Data

Remember, stock prices always have a delta of 1: We can take advantage of this knowledge and use straddles combined with going long or short shares to 'scalp' profits in a day trading strategy. You can learn more about this in module 11 video files that come with the popular Trading Pro System.

When assessing the viability of a delta neutral trade, you should also be aware of an associated 'greek' called the Gamma.

The GAMMA is the rate at which the DELTA changes in response to price movements in the underlying. It is the factor that causes a delta to change from Using a good option pricing model, you can use the gamma to calculate the theoretical delta and therefore the theoretical future price of an option, in response to price movements in the underlying. This is particularly useful if you are using options for delta neutral trading alongside futures or synthetic stock positions.

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