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Delta Neutral Trading

Posted by Pete Stolcers on June 1, 2006

In today’s option trading blog I will discuss the importance of having an opinion. I have an opinion about everything, why should my trading style be any different? Delta neutral trading means you don’t have a directional bias. The stock can move either way and you are “in good shape”. The strategies come in a variety of shapes and sizes but in general, I don’t like them.

As a trader you are an entrepreneur, a business person. Your objective is to make money trading and to grow your business. If you asked a successful entrepreneur for their opinion on an important company decision, what are the chances that the response would be, “I don’t know” or “It doesn’t matter to me”? I’ll tell you – nil. They are successful because they do their research and use information to substantiate their stance. They don’t want to muddle around and maintain their business, they want to take it in a direction. That direction will carry great risks and rewards. Trading is the same. You get paid well when you have an opinion.

There are many people who will woe you with sophisticated delta/gamma neutral strategies and charge you thousands of dollars to teach you “their” approach. In the end, the methods won’t work on a retail basis. Use your intuition and ask yourself if you think your riches lie in a strategy that “takes care of itself”. “Just buy our $3000 software program and subscribe to a live option feed for $250/month and make money like the pros.”

Most of these “systems” promote premium selling in a covered manner and they are called Iron Condors, 4-Ways and Butterflies. Each is a mulit-legged spread. They are trying to take advantage of high IV’s or time premium decay. The proponents of this strategy will be calling me to say that having and opinion on IV or an opinion on a trading range is an opinion. They will also call to tell me how much money they have made trading the system – bring it on.

My favorite part of the debate is when they start to explain how to adjust the position. Realize that for most people the position is truly delta neutral twice throughout the life of the trade – when it is established and when it’s taken off.

The fact of the matter is that there are more efficient ways to trade those opinions. If you think that the IV’s of a stock will drop, good luck. I hope you have a fantastic research department. The premium is there for a reason and retail traders don’t have the means to find out why. In an instant, the results of a clinical trial can send a stock spiraling. If you think the IV’s for the overall market are high there’s a product you can trade with a single bid/ask. If you think that a range for the market has set in, identify stocks with relative strength and weakness within the market and form an opinion. Look at all of the stocks that have made huge moves up and down while the market has been in a 5% range this year.

I do not consider credit spreads as neutral trading. There is one side of the trade that carries risk. It is simply a way for me to increase the probability of success when the risk is elevated.

There is one neutral strategy that I use very sparingly. I will on rare occasion find a straddle or a strangle that is worth buying. My risk is limited and I’m looking for a big move. BOL is the only straddle I’ve played this year. In March, I bought the April 65 straddle. The stock had fallen, the earnings were delayed and they had to recall one of their main products. The position was neutral and the stock was poised for an explosion in either direction.

In my next article I will introduce you to the options trading floor and give you a little history. The article will form the framework needed to shed light on these complex delta neutral spreads. If you trade them, stay tuned. Better yet, comment if you like.

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