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Is Delta-Neutral Trading Beneficial?


Yes -- for certain purposes. But it's not right for all positions.


Andy writes:

"A method I've seen to adjust deltas is to simply balance your position with calls and puts. For example, I'm bullish on Apple (AAPL) and buy five calls; but to neutralize delta, I also buy twp puts. Is this position more advantageous than simply buying three calls and no puts?"

1. If you're bullish on a stock, why are you thinking abut buying puts?

2. If you're bullish on a stock, why do you want to neutralize delta?

3. If owning five calls is too many and makes you a bit uncomfortable, then buy only three calls. Don't defeat your plan by owning two extra straddles.

What's behind this question? Why do you ask? If you believe that buying those two extra puts makes your position better or "safer" because it's nearer to delta neutral, then you don't quite understand the idea behind delta.

Buying two straddles is expensive and takes a fairly large move to earn a profit. Buying those two straddles decreases the likelihood that you'll earn a profit. Yes, it gives you a better result if Apple makes an extremely large move in either direction, but that's not what you anticipate, so why pay so much cash to own two straddles?

If the answer is to be "delta neutral" then you're missing a key point. There's nothing magical about delta neutral. The Greeks are used to measure risk. That's all they do. When you quantify the risk, you can decide whether to take steps to reduce that risk. You don't have to be delta neutral.

It's one way to reduce risk -- but it's your choice. Delta tells you how much you can expect to gain or lose when the stock moves one point. If that number doesn't work for you because it's too large, that's the time to adjust; that's the time to make the position closer to being neutral in delta, or any other Greek. But it's not mandatory to be Greek neutral.

In Apple, buying two puts when bullish is just throwing away money to reach some nirvana called "delta neutral." Forget that nonsense. If you're bullish, buy the three (or five) calls and forget the puts.

However, if your plan is to trade a "market neutral" strategy such as an iron condor, then owning a position that's near Greek neutral makes more sense. When you have no market bias, when you aren't wagering on a specific outcome (e.g., Apple stock moving higher), then being neutral is a sound choice.

Delta neutral is good for certain purposes. Don't latch onto that phrase and decide that all positions should be delta neutral. After all, people who buy stocks don't diminish their hoped-for returns by hedging. The majority remain naked long their stocks. It's okay to do the same, when appropriate.

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No positions in stocks mentioned.

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