Delta Neutral

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.