Delta neutral trading

[nerdzkilla]

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?

 

[wayneL]

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

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

 

[nerdzkilla]

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?

 

[village idiot]

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

 

[wayneL]

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.

 

[bingk6]

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??

 

[mazzatelli]

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.

 

[bingk6]

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.

 

[sinner]

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.

 

[wayneL]

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.

 

[wayneL]

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.

 

[sinner]

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!

 

[bingk6]

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.

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.

 

[ducati916]

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

jog on
duc

 

[mazzatelli]

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.

 

[wayneL]

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.

 

[wayneL]

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.

 

[village idiot]

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

 

[wayneL]

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

Mine

 

[village idiot]

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.