The strategies that have been discussed so far have signified either a bullish or bearish bias on the underlying stock. This chapter will introduce new concepts that allow investors to to take a neutral stance and profit. These concepts also help to recognize when an overall portfolio may be too heavily weighted to one side.
Sometimes investors believe that a stock is going to trade within a range until expiration. Others may believe that implied volatility is going to spike in the underlying stock. The great thing about options is that positions can be established to profit from these types of moves, or lack thereof.
However, in order to establish positions that single out and profit from these stances, an investor must establish a "delta neutral" position. Delta neutral simply means that the movement of the underlying stock will not affect the profitability of the position.
Delta Neutral
A non-linear position in which the position has a Delta equal to (or close to) zero.
If an investor purchases a call option that has a
Delta of .20 and also buys 2 put options with a Delta of -.10. The
Delta would equal:
Calls = (1 x .20) = .20
Puts= (2 x .-10) = -.20
Delta= (.20)+ (-.20) = 0
While investors are certainly not required to
have a delta-neutral portfolio, it is important for an investor to
hedge the portfolio from too much directional risk. For example, if an
investor has all long call positions and bull call spreads,
the overall portfolio Delta could be in the thousands. Even a small,
short-term pullback in the markets could lead to large unrealized
losses. Investors must be aware of their overall portfolio Delta at all
times and take proper measures to mitigate systemic market losses.
There are many different types of non-directional positions which investors can utilize to profit from the passage of time or increases in volatility. These strategies will be covered in this chapter.
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