A delta-neutral trading strategy is one that has no immediate directional bias. A Strangle and an Iron Condor are two specific types of trades that fit this approach. Today, however, we explain how these non-directional trades can become directional.
Our goal at order entry on a Strangle is to have zero deltas. We do this by selling the Call and Put options that have a 16 Delta, which is equal to a one standard deviation move from the current price of the underlying.
With no Delta exposure, time and volatility are the primary drivers of a trade’s potential profitability. However, it's important to understand how Gamma, Theta (time decay) and Vega influence the profitability of delta neutral strategies.
A delta neutral trade when short premium is one that speculates not on the direction of the underlying, but that the implied volatility (IV) overstates the realized move, underestimates the timing of the move, or both.
Unless the underlying does not move, eventually a delta-neutral trade will pick up a directional bias as the options become closer to being "in-the-money." The rule is that the new delta (directional) exposure of a delta-neutral trade is the opposite of the stock’s movement. For example, if you Sell a 1SD strangle, as the underlying's price increases, you will pick up short or negative deltas. As the underlying's price decreases, we will pick up long or positive deltas.
Watch this segment of Options Jive” with Tom Sosnoff and Tony Battista for the valuable takeaways and a better understanding of delta-neutral trading strategies, including what to expect as the underlying changes in price.
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