What Is Delta Neutral?

Delta neutral is a portfolio strategy utilizing multiple positions with balancing positive and negative deltas in order that the general delta of the assets in query totals zero.

A delta-neutral portfolio evens out the response to market movements for a certain range to bring the web change of the position to zero. Delta measures how much an option’s price changes when the underlying security’s price changes.

Because the values of the underlying assets change, the position of the Greeks will shift between being positive, negative and neutral. Investors who want to keep up delta neutrality must adjust their portfolio holdings accordingly. Options traders use delta-neutral strategies to profit either from implied volatility or from time decay of the choices. Delta-neutral strategies are also used for hedging purposes.

Understanding Delta Neutral

Delta Neutral Basic Mechanics

Long put options at all times have a delta starting from -1 to 0, while long calls at all times have a delta starting from 0 to 1. The underlying asset, typically a stock position, at all times has a delta of 1 if the position is an extended position and -1 if the position is a brief position. Given the underlying asset position, a trader or investor can use a mixture of long and short calls and puts to make a portfolio’s effective delta 0.

If an option has a delta of 1 and the underlying stock position increases by $1, the choice’s price can even increase by $1. This behavior is seen with deep in-the-money call options. Likewise, if an option has a delta of zero and the stock increases by $1, the choice’s price won’t increase in any respect (a behavior seen with deep out-of-the-money call options). If an option has a delta of 0.5, its price will increase $0.50 for each $1 increase within the underlying stock.

An Example of Delta-Neutral Hedging

Assume you may have a stock position that you simply consider will increase in price in the long run. You’re frightened, nevertheless, that prices could decline within the short term, so you select to establish a delta neutral position.

Assume that you simply own 200 shares of Company X, which is trading at $100 per share. Because the underlying stock’s delta is 1, your current position has a delta of positive 200 (the delta multiplied by the variety of shares).

To acquire a delta-neutral position, it’s essential enter right into a position that has a complete delta of -200. Assume then you definately find at-the-money put options on Company X which are trading with a delta of -0.5.

You can purchase 4 of those put options, which might have a complete delta of (400 x -0.5), or -200. With this combined position of 200 Company X shares and 4 long at-the-money put options on Company X, your overall position is delta neutral.