Alert

Looking for even more trade ideas? Sign up for Alpha Boost, a FREE email from quiet foundation!

P/L Ramifications of Trading Delta Neutral

Jun 8, 2017

By: Sage Anderson

In options trading, the "Greeks" provide valuable insight into the risk profile of a particular option or position. 

Theta tells us how much we are collecting (or paying) every day, vega tells us how much we can make or lose for a given move in volatility, and delta helps us understand how much an option's value will change as the price of the underlying fluctuates. 

Delta is a somewhat unique "Greek," because the term may also be used to describe the directional exposure of a position. 

For example, if a trader buys a naked long call, this position may be called "long delta" because it performs well if the underlying goes up. This is also a defined risk trade, from the perspective that the maximum amount the trader can lose is the total premium paid for the call. 

The term "delta neutral" refers to a strategic trading approach that attempts to neutralize directional exposure, using the underlying security of the option.

This approach is underpinned by the belief that by hedging directional risk, a trader can isolate the volatility risk (mean reversion) that he/she is trying to capture. 

Stated in more simple terms, trading delta neutral (when applied appropriately and consistently) can help traders reduce exposure in the event a position moves against them. On the flip side, this risk mitigation doesn't come without a cost - delta neutral trading can also take a bite out of potential profits.

In an effort to provide further context on delta neutral trading, consider the following hypothetical example. 

Imagine that two different traders have been following stock XYZ for several years, and each noticed that XYZ's products experienced a spike in demand over recent months. XYZ is currently trading $10/share, and the company is set to report earnings in two weeks.

 Intending to profit on a quick rise in the stock price after a good earnings report, both traders decide to purchase 100 contracts of the $11 strike front-month calls that expire in three weeks. They each pay $0.30 for the $11 strike calls, which equates to an outlay of $3,000.

Now consider one twist to the situation - while Trader A decides to sit tight with the naked calls, Trader B decides to hedge the position delta neutral. This means that Trader B will use the underlying stock to “flatten” the long delta exposure of the calls, as detailed below: 

Trader A: Trader A purchases 100 of the $11 strike calls for $0.30 with the stock trading $10. Trader A does no stock against the long calls. 

Trader B: Trader B purchases 100 of the $11 strike calls for $0.30 with the stock trading $10. The $11 strike calls have an associated delta of .30, and Trader B decides to hedge the position "delta neutral." This means Trader B sells 3,000 shares of stock XYZ short against his call position (# of contracts x option delta x option multiplier, or 100 x .30 x 100 = 3,000 shares).

 Now let's look at some hypothetical situations for the day of earnings, and see how each of the respective traders (A and B) perform:

Scenario #1: Company XYZ reports fantastic earnings and the stock opens trading $12 after earnings are released. 

  • Trader A: Trader A paid $0.30 for 100 calls that are now worth a $1.00. Trader A makes a profit of $7,000 on the trade ($0.70 x 100 x 100).

  • Trader B: Trader B also paid $0.30 for 100 calls that are now worth $1.00. However, Trader B additionally sold 3,000 shares of stock XYZ short for $10.00/share. That means Trader B has made $7,000 on his call position, but lost $2.00/share on the short shares ($2.00 x 3,000 = $6,000). Trader B, therefore, makes a profit of $1,000 on the trade ($7,000 - $6,000) with the stock trading $12. 

Scenario #2: Company XYZ report fantastic earnings, but simultaneously announces accounting irregularities at the firm that are currently being investigated by the SEC. Stock XYZ opens at $8.00/share after earnings are released. 

  • Trader A: Trader A paid $0.30 for 100 calls that are now worth at most a nickel, but likely will expire worthless. Trader A will likely lose his/her entire $3,000 investment in the call premium.

  • Trader B: Trader B also paid $0.30 for 100 calls that are now worth at most a nickel, but likely will expire worthless. Trader B will likely lose his/her entire $3,000 investment in the call premium. However, Trader B also sold 3,000 shares of stock XYZ short for $10.00/share. That means Trader B has made a profit of $2.00/share on the short shares ($2.00 x 3,000 = $6,000). Trader B therefore makes a profit of $3,000 on the trade ($6,000 - $3,000 = $3,000).   

The above example should help illustrate how a delta-neutral trading approach can affect the range of expected P/L outcomes for a given position. 

While the scenarios presented above represent extreme cases, traders can model any position for hypothetical moves in an underlying to gain a better understanding of their exposure. Likewise, traders can use this framework to ensure they have deployed a position that matches their outlook, expectations, and risk profile. 

Any position, no matter how complex, is simply the sum of its parts. By breaking down the P/L of each component of a trade, traders can best understand how different moves in an underlying will affect the overall position, and more importantly, the bottom line. 

We encourage you to model positions you are considering in the future to gain a better understanding of how they will perform under a variety of hypothetical circumstances. This type of activity can help unlock valuable information that traders can apply to future situations they encounter.

We are also planning some future posts covering additional aspects of delta-neutral trading, such as gamma scalping, which involves making adjustments on your stock hedge when the underlying moves. 

In the meantime, if you have any questions about delta neutral trading, we hope you'll reach out at support@tastytrade.com at your convenience.

We look forward to hearing from you! 


Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.


Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.

Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.

© copyright 2013 – 2021 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.