A delta neutral trade, simply stated, refers to a trade that will make money regardless of market direction. Thus, a delta neutral trader need not be concerned about the market direction. The strategy I mentioned in my previous post: the Iron Condor, is an example of a delta neutral strategy.
Suppose AAPL is currently trading at $180. To sell an Iron Condor, I may sell a $160 PUT and a $200 CALL (and at the same time buy a $155 PUT and $205 CALL to protect myself). As long as AAPL stay within the $160 and $200 range, it can fluctuation up and down within that $40 zone and I will still make money.
The main advantage of the iron condor is that there is no need to predict market direction. I always believe that unless you have a crystal ball, it is not possible to predict where the stock market will go the next day… or even the next minute, for that matter. Instead of being bullish or bearish on the stock, and predicting the direction of the stock, I predict where the market WILL NOT go. Personally, I found the latter a lot easier to do than the former and have had a much higher success rate.
Another advantage of a delta neutral trade is that your losses are normally lower. This is because only one side of your trade can be wrong. Put another way, at any time, at least one side of your trade will be profitable. For me, it is nice to know that I am at least ‘half’ correct.
For instance, suppose AAPL moves up to $199, threatening the $200 CALL position that we sold. If we are still a few weeks away from expiry day, our $200 CALL position will probably show a paper loss. However, even though we lose money on the CALL position, the $160 PUT that we sold will show a paper profit. Although this profit may be lower than our loss in the CALL position (resulting in a NET loss), the loss will be much lower than if we have only sold the $200 CALL. In fact, if the position has already been opened for a few weeks, it is often possible to exit at a very small loss.
Thus, unless a stock is trending very strongly and I am convinced that the direction will continue, I would prefer to enter a delta neutral position.
