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Futures Option Spreads – Delta Neutral Trading
There are many ways to trade futures option spreads. One way is to trade
spreads that can profit from time decay. You can sell options which you
believe will lose more time value than the options you buy.
Another way is to buy and sell options based on their deltas. Some of
these trades are called delta neutral trades. Delta neutral trades are
option trades in which the total delta of all the options is Zero. At the
money options have a delta of 50.
If you buy an at the money call, you will have a
delta of +50.
If you sell an at the money call, you will have a
delta of -50.
If you buy an at the money put, you will have a
delta of -50.
If you sell an at the money put, you will have a
delta of +50.
Basically, the deltas will be determined by where you want the market to
go. Think of it this way: If you sold an at the money call option, where
would you want the market to move to? You would like it to go lower. So,
you would have a delta of -50.
If you look at most at the money options, you will find that they are
usually not at 50. That is because they are not exactly at the money. We
still refer to these as the at the money options because they are the
ones that are the closest to being there. It might have a delta of 47 or
53.
If you purchased one at the money call and one at the money put, you
would be delta neutral. The call will have +50 deltas and the put will
have -50 deltas. The total is zero. This is a very simple delta neutral
trade.
Another delta neutral trade is a ratio back spread. An example of this
trade would be to sell an option that is at the money and buy a greater
number of out of the money options. You might sell one call option at the
money (delta -50) and buy 2 call options out of the money (delta +25
each). You would be delta neutral. You would want to put this on for a
credit or at even. You can also put it on for a debit but then you would
care a little about market direction.
If you put it on for a credit or even money and the market was lower at
expiration of the options, you would break even or earn a small credit.
If you put it on for a debit, you would lose the debit amount if the
market was lower at expiration of the options. In either case, if the
market went sharply higher, you have a chance for unlimited profit,
because you have purchased more options than you sold.
Most traders teach that ratio back spreads should be done in the far
months only. This is because you have more time to be correct with a big
move. The problem that I have found is that you are giving up too much
for the time advantage. The options you buy out of the money are not
priced at an advantage compared to the ones at the money. You can look at
the theta to see how much each option will lose per day or per week.
You can also see that in order to have a lot of time left in the trade,
the difference in strike prices between the option you sell and the
options you buy are too much. It will take a bigger move before you have
unlimited profit potential.
If you are expecting a big move, think differently than the norm and
start to look at options that have 20 -40 days left. The options you buy
compared to the options you sell, should be priced better. Everything is
in relation to something else.
So the next time you hear someone recommending the same old ratio back
spreads, take a look at the difference months to see where the real
advantage is.
Article Source: articledashboard
David Rivera has traded commodities and options for one the largest cash
trading firms in the world. He has written a course on futures options
which contain 2 specific trading techniques. You can find the techniques
in depth at: deltaneutraltrading
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