Delta Neutral
Categories: Derivatives, Trading, Investing
Like college frat parties, option trading involves a lot of Greek letters...
Here we’re going to look specifically at delta. The term refers to the amount the price of an option moves compared to movement in the price of the underlying asset. So you have an option to buy a stock at a certain price. The stock moves $1. How much does the price of the option move? The answer to that question gives the delta for that option.
A delta neutral strategy is one where the total delta equals zero. To achieve this, an investor will take a number of different positions. When the deltas for all the positions are added together, the answer is zero (or at least really close to zero).
To get to this point, you might get a put for a stock (an option bet that a stock might go down) while simultaneously buying some amount of the underlying stock. If the stock price rises, the value of the option will go down. The put has a negative delta. The stock itself has a positive delta.
Similarly, you could buy a call and a put for the same stock (a call, by the way, is an option bet that the underlying asset will go up in value). Again, the put will have negative delta while the delta for the call is positive.
As the price of the underlying asset changes, the delta values for the options related to that asset also change. So maintaining a delta-neutral position can take some tweaking.
So why take a delta-neutral position? Isn't that like...going to a roulette wheel and betting on black and red at the same time?
Not quite. In option trading, you can set up positions to take advantage of different kinds of situations. You might be looking to profit on implied volatility or on time decay, rather than trying to bet on the direction that the underlying asset will go.
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finance a la shmoop what is a derivative? well it's derived it's a something taken
from something else like a derivative of hot weather is thirst a derivative of [Girl takes sip of glass of water on a beach]
hunger is well you know crankiness that's diva thing you get there...
derivative of a 1/32 quarterback rating in the NFL is like serious wealth yeah
yeah discount double shmoop yeah look for it be on there with aaron
and a derivative of a stock or bond or other security is a something which
derives its value based on the performance of that underlying security
there are basically two flavors of derivative put options ie the right to [Ice cream flavors appear]
sell a security at a given price over a given time period and a call option, ie
right to buy a security at a given price over a given time period
well the price of that option is derived from the price of the security and a few
other factors like strike prices and duration and all that stuff
colonel electric the downgraded new version of General Electric is trading [Colonel Electric appears in a suit]
for 25 bucks a share a derivative of its share price is sold in the form of a
call option with a $30 strike price expiring about 90 days from now on the
third Friday of the end of that month well investors pay a price albeit
probably a small one for the right to then pay 30 bucks a share for colonel [Call option appears for colonel electric]
electric at any time in the next 90 ish days until that option expires making the bet
that the stock will go well above 30 bucks a share in that time period that
call option is thus a derivative of the colonel electric primary stock price got
it if you really want to get personal well here's the ultimate form of
derivative [Baby laying down]