Okay, this is Karl Domm, your Real P&L trader and I’ve been asked this question quite a few times so I just wanted to go over this. The question is: what is Delta neutral and how do you maintain Delta neutral; neutrality I should say. In other words, if you have a position that’s not Delta neutral, how do you make it Delta neutral?
So I’m just going to kind of go over a general way of doing this. So right now I’m going to start with, let’s just say a spread. I’m just going to kind of throw anything… Oh by the way, this software right here is called OptionNET Explorer and I highly recommend it. And if you want to sign up for it, I’ll leave a link in the description where you can get a 10% off of the software costs here if you want to get this software. This is the best backtesting software I’ve ever used and I highly recommend it.
Okay, so here we’re using $SPY as an example. We’re looking at the options. These are the calls on the upper side and these are the puts. Let’s just say we put a spread together, I don’t know, I’ll just throw something together real quick, like a credit spread, a call credit spread.
Okay, so we have this call credit spread now. I’m looking at the risk graph and I can see this is my T+0 line and these are my, what they call the T+X lines, right. So what happens in the future? This is 33 days out so, you know, kind of breaks this down into 7 days, 14, 21, 28. So 7 days later, this is what this is going to look like. And 14 days, this is what it’s going to look like. So and then at expiration, of course, you have your expiration line. That’s what it’s going to look like at expiration.
So there’s negative Delta. I’m looking at the Delta here, okay. Negative Delta. That’s negative. Negative 5.5 Delta. That’s what this position means. So if the Delta’s negative, you want the position to go down. It’s directional. Delta means directional. I mean, it means a lot of things but when we’re talking about how to get Delta neutral, if this was 0, then we would be neutral in terms of direction. Now, that’s only being zeroed out as far as Delta. The key is to be zeroed out with Gamma; that’s a whole different subject. But just we’re talking Delta here, so you can see that, you know, there’s a lot of risk to the upside.
So let’s say the $SPY goes from 386 to 410. Well, look at the P&L. Looking at this number right here, see it goes to 410, it’s down $116. So your risk is to the upside, you’re directional. Or if it goes to 370, you’re up $86, so there’s directional risk.
So how do you make this Delta here neutral? Well, we need to add 5 Delta. So let’s say here’s my Delta column and I want to make this thing neutral. So I’ll go up here, and let’s just say that I buy one, go long here, one call, five Delta so I’m basically adding 5 Delta. Now, look at my Delta. It’s pretty neutral. I’ve got some neutral Delta going on here and so this T+0 line just became Delta neutral. Right here where I’m, you know, at this particular price. You know, if the market goes up, it’s going to make money and if it goes down it’s going to make money. Hey, this is pretty good structure right here; but you can see over time, there’s some negative Theta here. But anyways, we’re just talking about Delta. So this is how you can get neutral. You can see how much Delta you have and then you can add that amount of Delta to the position.
So this is a spread and this is a way to make a spread Delta neutral, so this really is kind of not really a spread anymore because it’s got an extra long call, but that is one way to go get Delta neutral. I’ll do this with the iron condor. Let me put an iron condor together. Okay, so let’s do it at about 16 Delta. So we’ll go short here and we’ll go about five wide. We’ll do iron condor. We’ll go down this side. There’s no 16 so we’ll do it at 17 Delta. So -5, go long there. There we got our iron condor.
Are we Delta neutral? No, we’re minus 1.48 from being Delta neutral. So we need to, you know, adjust this a little bit. Let’s see, we put some more positive Delta in there, 0.69. There we’re Delta neutral. See how I added Delta here? I went from 11.5 to 13.22, so I added what, you know, two Delta or whatever it was. And there we are now, we’re Delta neutral. To see how I made an adjustment, I mean, you can do so many things to make adjustments. You can buy a put debit spread or sell a call credit spread. You can do all kinds of things to get Delta neutral. And you can see what that means is really is that you’re at a situation where you’re kind of at the peak, a lot just depends on your Gamma of course, but you’re flattening out your risk profile in terms of Delta, in terms of direction.
Okay, so that’s how you get Delta neutral. Let’s do that with a butterfly. So let’s do this butterfly, -10, and, -10. There we go, we have a butterfly. Butterflies are fairly Delta neutral. You can see it’s not at zero. So you want to maybe, you want to make this Delta neutral. Well, let’s just see what happens here. I’ll add this. I’ll create a trade here. So this is how you do it, you commit the trade. You just call it something. You commit that trade. Now, you have a trade that you can deal with. So let’s say this opened up at 8:10 a.m.. Let’s add some time to that. Let’s see what happened later on that day.
Okay, so later on that day, you can see that it moved outside the tent here. Well let’s say that we if we had a roll. Let’s say we come to the edge of the tent, and we want to get neutral again. Okay, what do we do? Well, we’ve gotta compensate for 6.75 Deltas. So we can do, we need to add positive Delta. So let’s say we want to put a call debit spread. So let’s say if I go 1 here and -1 there. There you go, so you can see the difference here 24.5, -18, it’s around 6.5. So you can see 6.5 Delta we’ve added by adding this call debit spread. And you can see that we got Delta neutral here, so that’s how you get neutral with your Delta. You make adjustments by adding or subtracting Delta and that’s maintaining Delta neutrality. Now, if you have any other questions about more advanced trading when it comes to options, I highly suggest that you come to my live stream every Monday morning at 7:15 a.m. and I go over my Safe Wheel Strategy. It’s what I call a Level 5 Strategy. And what that means is, it’s a premium selling strategy, but it’s also hedged. So it’s basically non-directional. So it doesn’t matter which direction, so it has that Delta neutral aspect to it; it’s more Gamma neutral.
But come to my live stream. The way to get to the live stream is to subscribe to the channel and then hit the notification bell, and you’ll get notified. That way you’ll get a reminder of when I’m going to do the live stream so you can see me trade live in the account, and I show my real P&L. And I show every trade that I make. And you can see my total portfolio, my netliq., my total P&L (I’m the only one that does that). And just this Safe Wheel that I’m giving away, it’s up over 20% year-to-date. And it’s just something that anyone can follow, learn about options, and also make money with a proprietary system that I give away for free. So we’ll see you guys on the live stream.
LINKS MENTIONED:
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