Traders take many paths to reach their destination.

Can your platform get you there?

Search apps and services to personalize the

NinjaTrader platform to meet your requirements.
Indicators, automated strategies, free tools & more.

Explore now at ninjatraderecosystem.com

Futures, foreign currency and options trading contains substantial risk and is not for every investor. Only
risk capital should be used for trading and only those with sufficient risk capital should consider trading.
Powerful Signals for Stocks & Commodities

Long Term & Short Term

Works with stocks, commodities, futures, options, FOREX, bonds for intra-day or position trading
Triple Confirmed Buy/Sell Signals

Traders Rave Over AbleTrend

SINCE 1994
ABLETREND 7.0 COLLECTED BY

Test-drive it to See All the Signals!

THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT
REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS
LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY
ACCOUNT
ACCOUN WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. THE TESTIMONIAL MAY NOT BE REPRESENTATIVE OF THE EXPERIENCE OF OTHER CLIENTS AND THE TESTIMONIAL IS NO GUARANTEE
OF FUTURE PERFORMANCE OR SUCCESS. TECHNICAL ANALYSIS OF STOCKS & COMMODITIES LOGO AND AWARD ARE TRADEMARKS OF TECHNICAL ANALYSIS, INC.
 Stocks & Commodities V. 34:02 (14–18): Profiting With Delta Neutral Positions by Stan Freifeld
TRading OPTIONS

No direction? No problem.

Profiting With Delta

Neutral Positions
Trading delta neutral positions is a strategy that is Why do you want a DN position?
used by professional and nonprofessional traders When you make a position DN, you are reducing the
to produce profits with reduced risk. The idea is to directional risk the position carries and as you’ll soon
remove the directional component from the position see in an example, the value of the position will not
so that profits can be made whether the underlying change over a small range of stock prices. You are, in
moves up or down. Here’s how to construct delta effect, insuring the value of the position over a range
neutral positions. of stock prices. This insurance can be thought of as
an expense of the position and so the profitability of
the position may be reduced. The range of stock prices

I
t’s not easy to make money trading, but when where the position is protected can be extended further
trading equities, at least the concept is clear: by also making the position gamma neutral, although
buy low and sell high, or sell high and buy I won’t be discussing that in this article. By reducing
low. When trading options, you have more alterna- the directional risk, you can base your strategy on
tives using spreads. It is not unreasonable to buy an one of the other variables that determine the value of
option that you expect will lose value and will result the position—usually volatility, sometimes the time
in a loss while simultaneously selling an option that to expiration, and rarely (especially in the current
you think will lose even more value and will result economic environment) on interest rates.
in a gain. The combination of the gain and loss will In the past, traders used DN trading to take advan-
yield a net profit on the spread. Oftentimes, an option tage of mispriced options, although finding mispriced
trader will determine that he can’t accurately predict options in today’s marketplace is not as easy as it
which way a stock will move and so will want to sounds. Others will make a position DN to protect
take the directional risk out of the equation. Employ- it from price swings over a short period of time.
ing this strategy is often referred to as delta neutral Finally, DN trading is also used in conjunction with
(DN) trading. gamma scalping, which is also beyond the scope of
this article.
Defining delta neutral To understand DN trading, you’ll need to know
A DN position is an option position that may also the definitions of the five greeks and several of the
include stock, where the sum of the deltas of the puts, characteristics of delta and gamma (see sidebar
calls, and stock is equal to zero or close to it. Since “Definitions.”)
deltas represent the risk associated with the directional
component of the position, more deltas (positive or Characteristics of delta and gamma
negative) represent greater risk. When I was a market Delta and gamma are generally expressed as per-
maker, I considered a position that was long or short centages. For example, the delta for one option can
LISA HANEY

less than 500 deltas to be DN. For retail traders, I be shown as 80% or 0.80, meaning that if the stock
consider a delta between -50 and +50 to be DN. price changed by $1, the option price would change

by Stan Freifeld

Copyright © Technical Analysis Inc. www.Traders.com

Stocks & Commodities V. 34:02 (14–18): Profiting With Delta Neutral Positions by Stan Freifeld

Copyright © Technical Analysis Inc. www.Traders.com

Stocks & Commodities V. 34:02 (14–18): Profiting With Delta Neutral Positions by Stan Freifeld

by $1 x 0.80, or 80 cents. However, the

delta for one option contract (represent- XYZ = 55.00 Position
ing 100 shares of stock) would be 0.80 Size Option premium Delta Delta $$$
x 100 or 80. When viewing delta this +6 Nov 50C @ 6.25 80 480 3,750
way, you can think of it as an equivalent -4 Jan 45P @ 2.10 -30 120 -840
stock position. -6(00) shares @ 55.00 100 -600 -33,000
Deltas for long call options range from 0 -30,090
zero for far out-of-the money (OTM)
options to 100 for deep in-the-money XYZ = 55.50 (+.50) XYZ = 54.00 (-1.00)
(ITM) options. Long put deltas range $$$ P/L $$$ P/L
from zero for far OTM options to -100 +6 Nov 50C@ 6.65 3,990 240 +6 Nov 50C@ 5.45 3,270 -480
for deep ITM options. Short options have -4 Jan 45P@ 1.95 -780 60 -4 Jan 45P@ 2.40 -960 -120
the opposite sign as long options. Long -6(00) shares@ 55.50 -33,300 -300 -6(00) shares @ 54.00 -32,400 600
calls and short puts will have positive -30,090 0 -30,090 0
deltas, whereas short calls and long puts Figure 1: delta neutral example. As the stock price increases to $55.50 or decreases to $54.00, the dollar
will have negative deltas. The delta of value of the position doesn’t change, so there is no gain or loss.
long and short stock is always 100 and
-100, respectively, and doesn’t vary as the price of the stock (remember the D and G are for one option contract)
changes. Here’s an interesting thought question: what is the
delta of cash? Answer: zero. ■■ Jan 40 put @ $1.10, D = -25, G = 4
The gamma of a long put and its corresponding long call is
positive. In fact, the gammas are equal in value. So a position To form a DN position without stock, you just need to calcu-
gains positive gamma when options are bought and negative late a ratio of the deltas. So 60/25 = 2.4, which means you will
gamma when options are sold. Since the delta of stock is 100 need to trade 12 puts for every five calls. Let’s look at three
and doesn’t change, and we know that gamma is the change in ways to make DN positions.
delta, the gamma of stock is zero.
1. You can buy five calls for every 12 puts and the position will
Formulas for delta look like this:
and gamma
We can always look at an option pricing calcu- +5 calls, D = 300, G = 40
lator to determine the greeks of our positions. +12 puts, D = -300, G = 48
However, to get a quick approximation, you 0 88
can use the following formulas:
2. Or you can also sell five calls for every 12 puts and the posi-
Let P = option premium, D = delta, G = gamma, and M = tion will look like this:
stock movement (+ for increase and – for decrease).
-5 calls, D = -300, G = -40
If the stock moves M, and assuming nothing else changes, -12 puts, D = 300, G = -48
the new P and D can be calculated using these formulas: 0 -88

P(new) = P(old) + M * D 3. Alternatively, if you are willing to add stock to the position,
D(new) = D(old) + M * G you can easily make any position DN:

Be careful to observe the signs of D, M, and G since they can be +5 calls, D = 300, G = 40
positive or negative depending on the position. Also, remember +8 puts, D = -200, G = 32
that a negative number multiplied by a negative number yields -100 shares D = -100, G= 0
a positive number. 0 72

How to make a delta neutral position Note that even though each of these positions is DN, the
There are a myriad of ways to make a DN position and it’s rela- gamma (and also the theta, vega, and rho) will be different in
tively easy. Let’s look at an example using two options and see each case.
how to combine them with and without stock to make some DN In the DN example in Figure 1, you’ll notice that the dollar
positions. On XYZ stock we see the following two options: value of the position doesn’t change as the $55 stock moves
up to $55.50 or down to $54. This is a nice and neat example
■■ Jan 50 call @ $3.00, D = 60, G = 8 meant to illustrate a point. Of course, in real trading the deltas
are changing as the stock price changes due to gamma and so

Copyright © Technical Analysis Inc. www.Traders.com

Stocks & Commodities V. 34:02 (14–18): Profiting With Delta Neutral Positions by Stan Freifeld

the gain or loss may not be exactly zero. XYZ Change Stock Calls Position P/L
Now let’s look at an example of how you can use DN to make
some profit in real trading. Here’s the setup: 45 -15% 4,500 0.24 4,428 -191
47.68 -10% 4,768 0.50 4,618 B/E
• XYZ = $53 49 -8% 4,900 0.68 4,696 77
• Implied volatility normally trades between 35–55% 50 -6% 5,000 0.85 4,745 126
• Earnings are coming out tomorrow
51 -4% 5,100 1.05 4,785 166
• IV is high at 60% and you project it will fall to 50%
after earnings are released 52 -2% 5,200 1.28 4,816 197
• Jan 60 call = $2.27, D=33.3 53 0 5,300 1.55 4,835 216
54 +2% 5,400 1.85 4,845 226
You can put on a position like this: 55 +4% 5,500 2.18 4,846 227
56 +6% 5,600 2.55 4,835 216
Position delta Cost
57 +8% 5,700 2.96 4,812 193
+100 shares @ $53, D = 100 100 $5,300
-3 Jan 60 calls @ $2.27, D = 33.3 -100 -681 60.84 +15% 6,084 4.88 4,620 B/E
0 $4,619 61 +15% 6,100 4.97 4,609 -10
Figure 2: results. Here you see the results one day after earnings are released.
The next day, IV does drop to 50% as predicted. You can see One day later after earnings are released, the IV dropped to 50% as predicted.
from the chart in Figure 2 that the position will be profitable
over a wide range of price changes, from down 10% to up
15%. This results in a nice annualized rate of return for this
one-day trade.
An option trader may not be able
Be aware of these pitfalls to accurately predict which way
Does this mean you’ve found the holy a stock will move and so will
grail of trading? I don’t think so. The first want to take the directional risk
obvious problem is that the stock can move
too far to the upside or downside. Then
out of the equation.
you also have the volatility projection. If
volatility doesn’t come in enough, or worse
yet, increases, which may happen due to
a swift price move to the downside, the Definitions
position can suffer losses. Since two of the
three short calls in the example are naked, there is a margin Delta—The change in an option’s premium relative to a
requirement and you will need the highest option trading ap- change in the price of the stock.
proval level from your broker. Because of those naked calls, Gamma—The change in an option’s delta relative to a change
this particular strategy cannot be used in retirement or cash in the price of the stock.
accounts and you also have the usual commissions, spreads, Theta—The change in an option’s premium relative to a
and other expenses eating into the profits. change in the time to expiration.
As a final note, those of you who are familiar with syntheti- Vega—The change in an option’s premium relative to a
cally equivalent positions may realize that the results obtained change in the volatility.
in the example can be duplicated without having to purchase Rho—The change in an option’s premium relative to a change
stock. The equivalent position would be to sell the January 60 in the risk-free interest rate.
straddle and to sell one additional Jan 60 call.
Note that with the exception of gamma, each of the greeks
Stan Freifeld is a former market maker and white badge floor relates to a change in the option’s premium. Gamma relates
official on the American Stock Exchange. He is a frequent to a change in delta.
speaker at trading shows and now runs a one-on-one option
mentoring program at McMillan Analysis Corp. He can be
reached via email at [email protected].

Further reading
Gopalakrishnan, Jayanthi [2014]. “Learning The Ropes With
Stan Freifeld,” interview, Technical Analysis of Stocks &
Commodities, Volume 32: February.

Copyright © Technical Analysis Inc. www.Traders.com

 Take the
Bond Challenge!
Use the IBKR Bond Scanner to compare
available yields against those of your broker.

Start Trading Today!

Interactive Brokers Rated #1
Best Online Broker 2019 by Barron’s* ibkr.com/comparechallenge

Member - NYSE, FINRA, SIPC – Supporting documentation for any claims and statistical information will be provided upon request. *Interactive Brokers
rated #1, Best Online Broker according to Barron’s Best Online Brokers Survey of 2019: February 25, 2019. For more information see, ibkr.com/info
Barron’s is a registered trademark of Dow Jones & Co. Inc.
03-IB20-1280CH1278
 Because you
can never have
too many
PowerTools

17 is Here
Featuring the NEW OptionScope™
and QuoteCenter™ PowerTools
Discover the latest features at metastock.com/whats-new
subscribe or renew today!
Every Stocks & Commodities subscription
(regular and digital) includes:
• Full access to our Digital Edition
The complete magazine as a PDF you can download.
• Full access to our Digital Archives 8999
1 year.................
$
That’s 35 years’ worth of content!

2 years............ 149
• Complete access to WorkingMoney.com $ 99
The information you need to invest smartly and successfully.

3 years............ 199
• Access to Traders.com Advantage $ 99
Insights, tips and techniques that can help you trade smarter.

PROFESSIONAL TRADERS’ STARTER KIT

A 5-year subscription to S&C magazine that includes
everything above PLUS a free* book, Charting The Stock
Market: The Wyckoff Method, all for a price that saves
you $150 off the year-by-year price! *Shipping & han-
dling charges apply for foreign orders.

5 years..........
$
29999
That’s around $5 a month!

Visit www.Traders.com to find out more!

Email: [email protected] • Phone: 206-938-0570 facebook.com/STOCKSandCOMMODITIES @STOCKSandCOMM