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Delta Neutral Hedging - Neutral Options Strategies - Options Trading Strategies - YouTube
Channel: Option Alpha
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Hey everyone.
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This is Kirk, here again at optionalpha.com.
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In this video tutorial, I want to talk about
Delta hedging and really, the Delta hedging
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fantasy that I think is out there.
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Traders have been carried away for years with
the concept of Delta neutral trading as a
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way to generate income while staying completely
non-directional.
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What we absolutely want to say is stay as
neutral as possible.
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I want to help you understand why staying
Delta neutral all the time is a complete fantasy
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and really unrealistic for retail traders
like me and you.
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First, here’s the thing.
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I get it.
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You want to be as neutral as possible and
make money regardless of where the market
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moves.
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We can do that more or less, but we can’t
always be 100% neutral to the market movement.
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It’s just impossible to do as a small retail
trader.
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Here's the setup.
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I want to go through an example here using
a USO iron condor that we had recently put
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on.
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You can see here this is a snapshot of our
account and on the left, you can see it’s
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a USO iron condor that we did in February,
we placed the trade back on December 29th,
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2014, so you can see that's the exact date
and we’ll use that here in a little bit
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on the charts to use that date.
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But what's important here is that the circle
on the right shows our new Deltas in the position.
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Our overall Deltas in this trade is 11.7,
so that means that we've got some positive
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Delta on this trade.
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But here's the thing.
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When we originally placed this trade, it was
completely Delta neutral, meaning that we
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didn't care where USO went initially when
we placed the trade because we were an even
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distance on either side of the market and
completely neutral in our original Deltas,
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but over time, the market has moved a little
bit, USO has dropped a little bit and this
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has created some more positive Delta in our
portfolio than we originally want to.
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Here's the setup.
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This red circle is when we originally traded
USO back on 12/29.
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You can see USO was trading just above 20
at that point and our short strikes were at
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25 and 16.
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You can see our short strikes on this iron
condor were evenly spaced apart, meaning we
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were 100% Delta neutral to begin with.
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But as USO has started to trade lower and
started to trade into the low teens, that
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means that our position is now more positive
Delta and that really means that we need the
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market to rally a little bit in USO for us
to get back to neutral.
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That makes sense because it’s starting to
test the lower boundary.
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If USO on the off chance had started to increase
and started to test the higher boundary, then
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we’d actually start to see our Delta shift
a little bit more negative because we need
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the stock to come back down to around 20 to
re-neutralize the position.
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Unless you have enough capital to continuously
adjust…
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Because you can see even in just a few short
weeks, our Deltas are now out of whack and
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not exactly neutral.
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But unless you have enough capital to adjust
and neutralize your Deltas, it's an impossible
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task to accomplish this because Delta is fluid.
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It’s always moving.
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It is not a stagnant indicator of how much
money you’re going to make or lose.
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As the stock moves and as your position changes
form as it gets closer to expiration or further
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from expiration, that Delta is going to move
dramatically.
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It’s impossible unless you’re constantly
making adjustments to be Delta neutral.
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That said, we can use and have shown before
that Beta weighting your positions and giving
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you some sort of adjusted Delta can help when
you go to rebalance.
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Even though we can’t be 100% Delta neutral,
we can use Delta and Beta weighting to our
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favor and to our advantage when we go to make
an adjustment.
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Here's a quick example of doing that.
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With that same USO position that we were looking
at, we went ahead and Beta weighted all of
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the iron condors that we currently have open
and working.
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This is just at the time of the video.
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We Beta weighted all of those Deltas to match
USO.
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You can see the USO Delta stayed exactly the
same at 11.7, but all of these other Deltas
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were Beta weighted and changed, so that they’re
comparing themselves to USO.
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Now you can see that compared to USO, we've
actually got negative Deltas in our iron condor
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portfolio.
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It means that we’re a little bit long oil
here and we actually need oil generally to
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maybe come down in most of these positions.
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This gives us a good frame of reference here.
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If we want to re-neutralize this position,
we’d actually go and try to look for a trade
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that gave us about 54 Deltas positive to re-neutralize
this and get it to somewhere around zero if
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we want to be completely neutral.
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That’s a really good example and hopefully
this video proves to you that this whole idea
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of being Delta neutral while it really sounds
great in textbooks and theory, it doesn't
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really work in the real world when it comes
to retail trading an options trade.
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As always, if you have any comments or questions,
please ask them right below this video and
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this lesson.
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Until next time, happy trading!
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