The Importance of Being Neutral
Nov 8, 2017
By: Sage Anderson
Today we are taking a closer look at historical data that helps illustrate how a delta-neutral approach performs over the long term, particularly as compared to directionally-biased volatility trading.
As a reminder, "delta-neutral" as it relates to volatility trading strives to minimize the "delta" (directional) exposure of a volatility position.
In practical terms, that means the delta component of P/L shouldn’t vary widely based on direction. The trade becomes more agnostic to direction, especially as compared to a strategy that does not attempt to hedge away delta exposure.
Those interested in greater details on the long-term performance of delta neutral trading will find a recent episode Market Measures extremely interesting.
The meat of the show revolves around a study conducted by tastytrade that compares the performance of a delta neutral strategy to a directional strategy (using data from 2005 to 2017).
The delta-neutral strategy examined in the study was a simple short strangle, which results in virtually "flat" delta exposure at the time of trade deployment. The directional strategy examined in the study was a simple short put position (30 delta), which possesses a slight bullish delta bias at the time of trade deployment.
The backtest used in the study included the following parameters:
Compared two different strategies using data from 2005 to 2017
Strategy 1: Short 16 delta strangles in SPY
Strategy 2: Short 30 delta puts in SPY
Incorporated closest to 45 days-to-expiration (DTE) options
Scenario 1: All options held to expiration
Scenario 2: Manage winners at 50% of max profit
The results, as shown below, demonstrate that the delta-neutral short strangle outperformed the short put by a substantial margin over the period examined:
As you can see in the slide above, the short strangle produced an additional 15% return as compared to the short put in scenario 1 (all options held through expiration). A good chunk of the added performance can be attributed to reduced delta bias. When the market goes down, the short strangle simply isn’t as exposed as the short put.
Under scenario 2, in which winners were managed at 50% of max profit, the short strangle outperformed the short put to an even greater degree (22% vs. 15%).
While you may not be currently incorporating a delta-neutral approach in your portfolio strategy, we think this episode merits closer inspection when your schedule allows. A shift in market conditions may also catalyze a shift in your philosophy.
If you have any questions about delta-neutral trading we hope you’ll leave a message in the space below or reach out directly at firstname.lastname@example.org.
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.
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.