A Method to the Madness

I can't recall the inspiration that led to my article last night about delta-neutral positioning. Since it has been out there, my Inbox has been screaming that it can't take it anymore and is thinking about leaving me (meaning I got a lot of e-mails). For the most part the questions are about HOW to create a delta neutral trade. Let me use a fairly simple example...

Let's say I have a $50 stock. I purchase a Oct 50 call which happens to have a delta of .50. I also buy a Oct 50 put option which comes with a delta of -.50. As you can see my delta in this trade equals zero. This means that if the stock shoots up $5...whatever amount my calls gain, my puts will lose. This leaves me neutral to price movement. A comment I saw was to be careful shorting vega when it is high. Why? If the price moves, I am immune to price movement!

Hopefully this simple example gives you an idea. Like I mentioned earlier, I will tone it down and mix in various topics to keep everyone entertained and content.

Jeff,

Great example - we call that K.I.S.S. (keeping it simple stupid). BTW? How often are you able to play these?

Thx,

Randy

Jeff,

Please keep pushing the advanced topics. It's okay to mix in the basics, but this is incredibly valuable information you're providing.


I know i've mentioned this to you before, but I would like to suggest as a topic that you describe daily life as a trader. What trades do you focus on? How do you manage your account? Are you set up as a company? For those of us, like me, who are planning to turn this into a career, we're a little in the dark. There aren't any books out there teaching you how to trade for a living (even 'trading for a living' falls short in that area!).

If you don't want to make a topic out of it, perhaps you'd like to write a book so the rest of us will know the best path to take.

Thanks!

I agree with Brett any details about your daily nitty griity routine would be helpful(i.e. how much time each day you spend trading,reviews,+searching). BTW I love how you push us to think a little deeper each time. Keep up the great work!

Encore! Encore!

Love the blog! I have a question on a downtrending stock that just broke out of a descending triangle on higher than recent volume. BTU just broke out (in my opinion) with a target of 33. Not a bad potential move... The question I have follows: The IV is at a relative low - 11% and the vega is slightly positive, 0.0117 on the Oct 40 put. Does this mean that my option price movement will be based almost entirely on the underlying stock movement in the beginning and then a little more on time if IV rises? I ran a few cases with the BS calc and this seems to be true. Should I skip this trade and look for another breakout with a higher vega at the same option to strike price ratio/relationship (slightly out of the money)? Thanks in advance for the advice and keep up the great work!

Another vote here Jeff to not do away with advanced stuff. The complicated nitty gritty of greeks, IV and so forth seem to be what Investools is a bit short on. I love the company and what they've taught me, but they do seem to appeal to the lowest common denominator.

As for the Delta Neutral trade when IV is high, the example you give here is going long rather than short. Reversing that position to be short Vega, you would be selling a straddle. The margin for such a trade would be pretty tough to make it worthwhile I'd think. Maximum Loss potential, unlimited.
In order to define your risk, it seems you would either need to use an iron condor or a "Double Diagonal" as the people at Thinkorswim call it.
The theory behind a delta netural short vega play (credit spread of some kind) is great, but the reality is a bit elusive at first.
Credit spreads should be a part of any trading arsenal, burning time and Volaility, however you look at it.
But while the probability of success is higher, the max gain is less and the potential loss is much greater, percentage-wise.
I wish Investools would talk more about defending/closing credit spreads gone bad. It's quite a dilemna.
Please do a posting at some point on defending credit spreads. It's a lot more complicated to consider than just where breakeven is.

Many thanks!
Matthew

Brett N. (great name!),

I took the BTU trade a few days ago as well, and i think it looks good right now. However, with the IV so low and beginning to rise, i bought more time than you did so that in October when i hope to sell it, the IV will have risen giving the option a big boost in price (especially right before earnings). I think if you buy the Octobers, and you sell it near expiration, the time value component is gone, so the rise in IV won't help you with the option price.

Jeff, am I understanding this correctly?

Thanks,

Brett

Brett & Brett N,

Thsi is correct. The more time you have until expiration, the greater your vega will be.

Nice Work!

Jeff

Hi Jeff,
I love the more advanced concepts. Each time you bring out a new one, it inspires me and probably many others to find out all they can about it. We aren't supposed to understand everything perfectly right away. If it was that easy, everyone would be doing it. Please keep challenging us!
Debbie Davis

Post a Comment
...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT... ...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...

About me

  • I'm Option Addict
  • From Saratoga Springs, Utah, United States
  • I am a professional trader and an instructor for Investools. I've had relations with the markets for 9 years. Born in Concord, CA, but reside in Saratoga Springs, Utah. Father of THREE, Husband of one.
My profile

Prescriptions Here!

Other stuff

Blogarama - 
The Blog Directory
Directory of 
Finance/Business Blogs Finance 
blogs Top Blogs Finance Blogs - BlogCatalog Blog Directory