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Nov 8, 2017

The Importance of Being Neutral

By:Sage Anderson

We've discussed previously on the blog the definition of delta-neutral trading, as well as outlined how such an approach can affect position P/L under a variety of different scenarios.

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

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.

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