Delta Neutral Trading Woes

Delta Neutral Trading Woes

What is Delta neutral trading? You will often hear that it is the secret to making money no matter which way the market may move. The truth is that being aware of Delta is imperative to good option trading strategies, but it is not the answer to all of your financial woes.

Delta sometimes called the hedge ratio is an option's sensitivity to movements in the underlying security. When the option is at the money then delta is at its highest. Delta neutral trading is hedging your position against wild market swings by using spread strategies to cancel out the direction the market takes.

One simple way to trade Delta neutral (and to refute its touting as a magical black box system) is to buy a straddle or strangle, or to sell either. This is important, these are both delta neutral strategies, but only one can make money at a time. If I were to buy one strangle (one call and one put at the same strike price) at a $30 strike price for $5 per contract for ABC stock and the stock were to reach $50 at expiration, I would make a cool $1500. That is $5000 income from the call minus the $3000 I would pay for the stock minus $500 I previously paid for the spread. Sound great until I consider the other side, which was also delta neutral. The other side sold the spread for a $500 premium, but at the end of the day lost $1,500 on a perfectly delta neutral trade.