# Delta neutral trading



## nerdzkilla (20 January 2012)

Having trouble understanding this. Most of the gurus recommend it and boast about how much money they have made doing this..

From what I read, you buy/sell to bring delta of the overall trade to zero. that just confuses me.. can someone please answer the questions i have regarding this

Does that mean we ignore the time value of the options and let the options expire worthless if the overall delta is set at zero? 

How exactly do you make a profit when you continuously selling/buying options/stocks? How do you know you are making a profit? 

Do you ever close out the entire trade or you just go on forever?

If done properly what returns can we expect from delta neutral trading?  5%? 10%? 20%!?!?! 

Is there a book you would recommend I can read to learn about this type of trading?


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## wayneL (20 January 2012)

1/ Do you want to know about gamma+ or gamma- strategies?

2/ Don't believe everything you read... especially from "gurus".


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## nerdzkilla (20 January 2012)

wayneL said:


> 1/ Do you want to know about gamma+ or gamma- strategies?
> 
> 2/ Don't believe everything you read... especially from "gurus".




Hi Wayne,

Sorry i don't know the difference between the two..

I have been following your threads for a while now..what annual return can we expect from delta neutral trading?


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## village idiot (21 January 2012)

> I have been following your threads for a while now..what annual return can we expect from delta neutral trading?





well in theory, zero, since in theory the amount that would be made (or lost) by continously rehedging to delta neutral should exactly the same as the amount paid (or recieved for) the option(s) - that is the basis of the whole Black-Scholes model valuations. 

To have a positive expectancy you would have to find options priced at less than (or more than) the amount that can be made (lost) by the rehedging strategy, ie the options are priced 'too cheap' (or too expensive). This is not a typical state of affairs. 

In fact in the real world the EV isnt even as good as zero, since the expectation is only zero in a world with no transaction costs, and to adjust a hedge often in the real world incurs significant transaction costs.



I think Wayne is asking you if the gurus are refering to strategies that involve *buying* options and rehedging to delta neutral or *selling* options and rehedging to delta neutral. They are exact opposites although both can be delta neutral trading. Obviously they cant both be +EV


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## wayneL (6 February 2012)

nerdzkilla said:


> Hi Wayne,
> 
> Sorry i don't know the difference between the two..
> 
> I have been following your threads for a while now..what annual return can we expect from delta neutral trading?




The answer to this question is "How long is a piece of string"... anything from -100% to 874584487% I guess.

I would hesitate... nay, refrain altogether from quoting annual returns on any kind of option strategy; hell, any strategy at all!

Before GFC, I was doing a lot of delta neutral -gamma stuff. It was my bread and butter for a while there. But what you do not want with this sort of strategy is fast uni-directional moves and rising volatilities.

Sure there is option Kung Fu tactics available where you can move the goal posts around as the market develops (if you will forgive the mixed metaphor), but every morph costs you money. Too many morphs is like death by a thousand cuts.

The art of war is picking battles you can win so I have mothballed -gamma delta neutral strategies for future battles.

My point is that options give you a toolbox to construct market specific strategies and any thoughts of using one particular strategy ad infinitum will cost you dearly at some point. IOW, the various morphologies of what is called "delta neutral" have their time and place, but any talk of "annual returns" is twilight zone stuff used by seminar clowns to hypnotize people with. 

I'll talk annual returns on July1.


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## bingk6 (6 February 2012)

wayneL said:


> I have mothballed -gamma delta neutral strategies for future battles.




Wayne,

With a gamma and delta neutral strategy, do you find that you are sacrificing too much theta and therefore potential profitability ??

Secondly, do you do any vega hedging by using positive vega delta neutral strategies like double calenders and double diagonals together with your iron condors??


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## mazzatelli (6 February 2012)

bingk6 said:


> Secondly, do you do any vega hedging by using positive vega delta neutral strategies like double calenders and double diagonals together with your iron condors??




Thats a lot of legs to maintain a position.


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## bingk6 (6 February 2012)

mazzatelli said:


> Thats a lot of legs to maintain a position.




Sure, I didn't mean to use double calenders/diagonal purely as a vega hedge, that would certainly be an overkill as there are certainly much simplier ways of achieving that. However, in putting forth an overall delta neutral strategy, it might make sense (well to me at least) to have some spreads that are  positive vega and some that are negative vega so that the overall position can be somewhat vega neutral as well.


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## sinner (6 February 2012)

My understanding of "delta neutral" was that there were actually two main strategies which could be implemented (correct me if I'm wrong here):

1. Gamma scalping, which is what's described above, where you are "actively" trying to take a profit from moves in either direction.
2. A more "passive" approach, which takes its profit from vega, i.e. you believe vega in the options to be low (or high) and so you take a position looking to make up some of the difference between realised/implied vol. When the difference narrows, you exit.


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## wayneL (6 February 2012)

bingk6 said:


> Wayne,
> 
> With a gamma and delta neutral strategy, do you find that you are sacrificing too much theta and therefore potential profitability ??




Delta *and* Gamma neutral?  What specific position did you have in mind here?




> Secondly, do you do any vega hedging by using positive vega delta neutral strategies like double calenders and double diagonals together with your iron condors??




No. If I'm bullish on vega, I don't want to be delta neutral. To me it's an oxymoron.


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## wayneL (6 February 2012)

sinner said:


> My understanding of "delta neutral" was that there were actually two main strategies which could be implemented (correct me if I'm wrong here):
> 
> 1. Gamma scalping, which is what's described above, where you are "actively" trying to take a profit from moves in either direction.
> 2. A more "passive" approach, which takes its profit from vega, i.e. you believe vega in the options to be low (or high) and so you take a position looking to make up some of the difference between realised/implied vol. When the difference narrows, you exit.




You can't do both at the same time? 

There are lots of delta neutral strategies, not confined to the above.


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## sinner (6 February 2012)

wayneL said:


> You can't do both at the same time?
> 
> There are lots of delta neutral strategies, not confined to the above.




Sure, there is no limit to what you "can do", but I figured the above were the common ones which are used to most efficiently express a market viewpoint. I am sort of feeling the OP was referring to gamma scalping which is why I listed them.

Now you've got me curious, can you elucidate some other "strategies"? Ever since I learned about them I have been in love with the long straddle so never bothered to examine far beyond there. The ultimate trading strategy of our time, if you ask me!


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## bingk6 (6 February 2012)

wayneL said:


> Delta *and* Gamma neutral?  What specific position did you have in mind here?




I didnt have a specific position in mind. I was refering to your earlier statement that you had initially traded -ve gamma delta neutral strategies (eg iron condor), but because of the recent big downward market moves and therefore huge spikes in IVs, and as a result you had converted to strategies that were both gamma and delta neutral, presumably to cut down on the number of adjustments that you needed to make. At least that was how I read your earlier post ..... So I was trying to find out more about gamma and delta neutral strategies from you.




wayneL said:


> No. If I'm bullish on vega, I don't want to be delta neutral. To me it's an oxymoron.



Iron Condors are -ve vega and delta neutral (well usually), so I dont understand how that is any less of an oxymoron. At the end of the day, securities can still trend and have declining IVs.


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## ducati916 (7 February 2012)

If you are looking for Options strategies when volatility ramps up, go to gamma scalping instead.

jog on
duc


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## mazzatelli (7 February 2012)

bingk6 said:


> Sure, I didn't mean to use double calenders/diagonal purely as a vega hedge, that would certainly be an overkill as there are certainly much simplier ways of achieving that. However, in putting forth an overall delta neutral strategy, it might make sense (well to me at least) to have some spreads that are  positive vega and some that are negative vega so that the overall position can be somewhat vega neutral as well.




imo, its not optimal to try and isolate +theta without a view on price &/or vol, since these can easily reverse and more, any +theta gains.

From what I've seen, educators and brokers love promoting these. Takes out the need to think/predict and lots of legs for commissions.


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## wayneL (7 February 2012)

bingk6 said:


> Iron Condors are -ve vega and delta neutral (well usually), so I dont understand how that is any less of an oxymoron. At the end of the day, securities can still trend and have declining IVs.




Bullish vega has directional implications most of the time ('cept when leading up to major announcements). 

I'll take delta with my long vega thanks.


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## wayneL (7 February 2012)

sinner said:


> Now you've got me curious, can you elucidate some other "strategies"? Ever since I learned about them I have been in love with the long straddle so never bothered to examine far beyond there. The ultimate trading strategy of our time, if you ask me!




Delta neutral is technically any strategy with zero delta, which means we are trying to trade one or more of the other Greeks sans any input from delta (initially at least).

Therefore we can leave aside locked positions such as conversions/reversal, boxes and the like as they are flat everything (unless you've managed to score and unlikely arb). 

There are the obvious ones

Straddles/strangles
Condors/Butterflies
Double Diagonals
Horizontal spreads

But the following can be configures delta neutral also

Ratio spreads
Backspreads
Risk Reversals
etc

Worth noting that all of the above can be put on + or - delta as well.


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## village idiot (7 February 2012)

wayne, whose blog is that link you have as your signature ?


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## wayneL (7 February 2012)

village idiot said:


> wayne, whose blog is that link you have as your signature ?




Mine


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## village idiot (7 February 2012)

awesome. i trust you will be extending the trial to include periods where the underlyings dont go vertical by 27% in two months or so.


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## bingk6 (8 February 2012)

mazzatelli said:


> imo, its not optimal to try and isolate +theta without a view on price &/or vol, since these can easily reverse and more, any +theta gains.




The usage of Delta Neutral strategies, by its very nature, would tend to imply that one is not particularly keen to have a view on price, otherwise they would go for the directional trades. Volatility on the hand, because of its mean reverting tendencies, can, imo, be forecast (for one of a better word) more reliably then prices could be. So times like now when IV is fairly low (for the indices), spreads could be put on which are +vega with a slight -delta bias. That way when the big moves in the underlying take place, the +vega can be counted upon to provide some assistance to these +theta strategies. Workable strategy ??


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## mazzatelli (8 February 2012)

bingk6 said:


> The usage of Delta Neutral strategies, by its very nature, would tend to imply that one is not particularly keen to have a view on price, otherwise they would go for the directional trades.




I am assuming we are referring to a delta neutral position now rather than a 
delta and vega neutral portfolio (as I was assuming before)?



> Volatility on the hand, because of its mean reverting tendencies, can, imo, be forecast (for one of a better word) more reliably then prices could be. So times like now when IV is fairly low (for the indices), spreads could be put on which are +vega with a slight -delta bias. That way when the big moves in the underlying take place, the +vega can be counted upon to provide some assistance to these +theta strategies. Workable strategy ??




Generally yes, depends on what your 'slight delta bias' is. E.g. Trading a calendar where it is minimally otm will likely have gamma/dgamma losses exceed +vega gains, despite your view of vol being correct.

How much faith should be put in mean reversion of vol? Just to stir the pot, if a basic GARCH(1,1) is fitted to analyse index vol, suggesting clustering effects dominate mean reversion tendencies.


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## sinner (8 February 2012)

mazzatelli said:


> How much faith should be put in mean reversion of vol?




The one million dollar question...

To me it seems mean reversion is quite good from high vol to the mean, but much less reliably so from low vol to the mean.


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## village idiot (8 February 2012)

> To me it seems mean reversion is quite good from high vol to the mean, but much less reliably so from low vol to the mean.




ah, you have just summarised in one short sentence what I just spent 2 paragraphs typing out.....


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## mazzatelli (8 February 2012)

sinner said:


> The one million dollar question...
> 
> To me it seems mean reversion is quite good from high vol to the mean, but much less reliably so from low vol to the mean.






village idiot said:


> ah, you have just summarised in one short sentence what I just spent 2 paragraphs typing out.....




When is the vol arb fund opening fellas?


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## wayneL (9 February 2012)

mazzatelli said:


> When is the vol arb fund opening fellas?




Bill Luby had an interesting idea the other day:



> The holiday season has a shortage of trading days and a history of a bullish bias. As a result, December VIX futures have a tendency to remain relatively muted when compared to January VIX futures. Assuming I am able to establish this position for a net credit, a seasonal play on volatility involving short VXX calls paired with long VIX calls has an opportunity to profit if any one of three critical factors dominates:
> 
> volatility declines and both options expire worthless
> the VIX futures remain in contango
> volatility spikes and the VIX is more sensitive to the spike than VXX




Haven't looked into it, but on the face of it, some sort of VIX/VXX pairs trading seems to make sense.

Thoughts?


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## village idiot (9 February 2012)

> Haven't looked into it, but on the face of it, some sort of VIX/VXX pairs trading seems to make sense.




first thought is , well VXX = VIX, since VXX is a combination of the front two months VIX futures, so you would have to find some sort of pricing anomoly to make that profitable. 

second thought; assuming he is talking about same month (since he talks of both expiring together), it gets more interesting. A bet on Dec VIX is a bet on where spot VIX ends up on the xth december. A bet on Dec VXX is a bet on where VXX ends up on xth December, but because of the way VXX rolls from the front month to the next available month daily,  on xth dec expiration day VXX would consist 100% or near to it of  Jan VIX futures (or maybe Jan + Feb)

net result
long VIX calls => long Dec vix
short VXX calls => short mainly Jan vix


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## sinner (9 February 2012)

mazzatelli said:


> When is the vol arb fund opening fellas?




When I can find a decent model or some serious size? My options model is still the same, just long vanilla straddles when it thinks the time is right otherwise in cash.

I have one good idea for vol arb (slightly unconventional I believe) but it needs big stakes behind it. I found a good collar model but the returns are quite similar to my regular model.


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## village idiot (9 February 2012)

mazzatelli said:


> When is the vol arb fund opening fellas?




when i can find anyone rich and dumb enough to give me 20% of winnings without penalty for losing, for executing a pretty basic strategy. Then what would I care whether its profitable or not........


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## wayneL (9 February 2012)

village idiot said:


> when i can find anyone rich and dumb enough to give me 20% of winnings without penalty for losing, for executing a pretty basic strategy. Then what would I care whether its profitable or not........




I'll be in a fund like that


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## mazzatelli (10 February 2012)

wayneL said:


> Haven't looked into it, but on the face of it, some sort of VIX/VXX pairs trading seems to make sense.
> 
> Thoughts?



 Sorry, not many. 

I haven't modelled the term structure of VIX futs extensively, but there is definitely no arb between VIX/VXX calcs.

Considering  Dec and Jan tend to be quiet/stagnant, the term structure will  generally hold as upward sloping, so would fulfil his second critical  factor listed. I had a quick glance at recent VIX futs, Nov and Jan were  priced higher than Dec.

Seems a solid idea, but would have to  check the persistence of this cycle and effect on the calls due to  differing expiry dates of the ops.


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## DeepState (28 December 2014)

Any guru out there trading gamma on equity indices or FFX?


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## hhse (30 December 2014)

nerdzkilla said:


> Having trouble understanding this. Most of the gurus recommend it and boast about how much money they have made doing this..
> 
> From what I read, you buy/sell to bring delta of the overall trade to zero. that just confuses me.. can someone please answer the questions i have regarding this




Hi,

When they talk about delta neutral strategies, they are talking about removing the risk of market up/down moves to your portfolio. To do this, you will have a mix of bullish/bearish plays in your portfolio e.g Sell Call on Apple (Bearish), but Sell Puts on the NASDAQ (Bullish) - note, maintaining delta neutral is an ongoing thing, as this will change as your underlyings move.

However, your main source of profit in options let's say, would be from theta decay (time decay) or collapse of vega (Volatility). However, in this strategy, you need to ensure that you practice good bankroll management, and also watch your vega risk. To do this you will need a mix of strategies.

Returns will vary depending upon your tolerance for risk, but consistent returns between 15% - 35% would be realistic.

Hope that helps.


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## DeepState (30 December 2014)

hhse said:


> Hi,
> 
> When they talk about delta neutral strategies, they are talking about removing the risk of market up/down moves to your portfolio. To do this, you will have a mix of bullish/bearish plays in your portfolio e.g Sell Call on Apple (Bearish), but Sell Puts on the NASDAQ (Bullish) - note, maintaining delta neutral is an ongoing thing, as this will change as your underlyings move.
> 
> ...



Are you active in this space or are you delta or vega oriented? I am interested in harvesting the premium for neg skew available from neg gamma with delta hedged via algo. For me, neg skew with controlled risk exposure in a diversified arrangement is easy to bear..taking into account conditional correl effects. All positions would be massively overcollateralised. Overall, I see this as extracting another risk premium apart from equity risk and other smart betas. Would be good to have a thought partner if interested.


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## hhse (30 December 2014)

DeepState said:


> Are you active in this space or are you delta or vega oriented? I am interested in harvesting the premium for neg skew available from neg gamma with delta hedged via algo. For me, neg skew with controlled risk exposure in a diversified arrangement is easy to bear..taking into account conditional correl effects. All positions would be massively overcollateralised. Overall, I see this as extracting another risk premium apart from equity risk and other smart betas. Would be good to have a thought partner if interested.




Hi,

I trade predominantly short call/put options in u.s market around the 1.2-1.3 S.D OTM points and 55-45 DTE. I place greater emphasis on probability of ITM/OTM and volatility than I do with other greeks. I keep a mental note of deltas (negative at the moment, not trying to stay neutral). By default, I'd have a low gamma risk because of my entry & exit points (out of trades usually >15 DTE), but don't use it as a measure/filter. Volatility skew does not concern me either, I'd still sell the other side as it does not require additional margin and P&L appears to be positive despite POP decreasing.

I rely on third party sites for information as I don't have access to options data to back-test and don't know what programs to use.


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## DeepState (30 December 2014)

hhse said:


> Hi,
> 
> I trade predominantly short call/put options in u.s market around the 1.2-1.3 S.D OTM points and 55-45 DTE. I place greater emphasis on probability of ITM/OTM and volatility than I do with other greeks. I keep a mental note of deltas (negative at the moment, not trying to stay neutral). By default, I'd have a low gamma risk because of my entry & exit points (out of trades usually >15 DTE), but don't use it as a measure/filter. Volatility skew does not concern me either, I'd still sell the other side as it does not require additional margin and P&L appears to be positive despite POP decreasing.
> 
> I rely on third party sites for information as I don't have access to options data to back-test and don't know what programs to use.





Thanks.  To repeat my understanding:

So you are neg gamma if not intensively so.  Write options with presumably variable ratios on call and put wings OTM at inception and roll forward via calendars to maintain approximate maturity.  Target deltas at inception (ie look at ITM/OTM) but are not tightly managing these as a book subsequently. Happy to sell into skew....noting that this is profitable (this is where we are highly aligned, if the actual implementation is not identical).

Bottom line appears you are seeking to profit from theta decay and opening positions based on a set of rules related to initiation delta.  Although you keep an eye on vol, I am not sure what you are doing with this information.  I do not know how you find mis-valuation as opposed to using the above to shape the payoff.

If this is correct, a key difference between what I am seeking to do and what you are doing is tightness of delta hedging. For discussion purposes right now, the actual positions mean less to me than the greek outcomes which are broadly similar apart from the fact that you are happy to let delta roam. If gamma got too large and pin risk became an issue, I would roll.  In reality, I look for discontinuities in the vol surface that were not well explained for position initiations and try to get a desired strategy shape across a range of metrics.

I built my own backtest engine back in the day.  MatLab infrastructure.  I presently have a blank sheet of code space waiting to be filled again if I go ahead with this.  The underlying method for this purpose will be Black's approximation for the most part, but I will also build in a binomial lattice in case I need more flexibility for GARCH effects or events.

For my purposes, if IV exceeded realised vol, a profit was made as everything would be hedged continuously etc. Obviously this is an approximation, but one which is adequate for my purposes.  The differences between the approximation and reality are what creates the edge. There is almost always be a bias in IV and skew due to risk management concerns and frictions.  I am seeking to arb that because I do not face specific elements of those concerns in the same way and am more prepared to accept basis given smaller relative position sizes, available cross-sectional diversity and propensity to accept time diversification.  The underlying argument is hardly rocket science and is simply one relating to the price for risk bearing.

I have history and live data on active series.  I do not have it for historical, inactive, series.  Backtests would need to be of the type that uses current options pricing and historical market developments. Kind of like shock tests based on historical data.  It would also give an idea of the distribution of return outcomes for a given strategy, even if the mean is off.   Backtests for options are quite different in purpose than for other types of equity strategies for this strategy type so full history is not actually needed by me if I have VIX vs realised.  The rest is risk management.

If you wish to collaborate at some level, the key areas of overlap in terms of objectives seems to relate to viewpoints on what represents value in the outer wings to neg gamma traders.  Position sizes may also vary depending on views on what value is inherent in the current level of IV, skew and calendar effects.  Possibly, you may have a wish to share/exchange views on re-hedging delta.  I will do this via algo, but there will be acceptable basis risk which can be tightened with discretion. S&P 500 would be a good enough place to start as any.

It would be great to get an active forum of less directionally oriented option traders going here.  Please let me know if some form of collaboration might be useful to you (and others...)


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## hhse (31 December 2014)

DeepState said:


> Thanks.  To repeat my understanding:
> 
> Although you keep an eye on vol, I am not sure what you are doing with this information.  I do not know how you find mis-valuation as opposed to using the above to shape the payoff.




I'm more likely to sell premium in trades with a higher implied volatility percentile/rank vs. the year's range and will have more % of total capital invested when VIX > 15 than say <15 (~60% vs 30%) - these allow me to go further OTM. If I feel I have too many short vega on in low IV environments, then I will think twice about selling premium on downside or I'll either not put on trades OR buy a spread/calendar/diagonal.

Average monthly Implied volatility in general has exceeded historical volatility over the last 10 years (except 2008) - it's the 2008 incidents that I'm always conscious of. I don't have any hard fast rules, I choose whatever strategy that suits me then. The only hard fast rule that I follow is not letting my options expire, and taking my winning trades off about 30-50% range. I keep things simple, so I can sleep at night.


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