This segment examines the concept of a delta neutral portfolio and how it applies to and can be achieved by using stocks, option on stocks, futures and options on futures. What was once fairly difficult is made simple using the Dough platform.
There are several reasons why we would want a delta neutral portfolio. Sometimes it would be a temporary hedge, sometimes it is to lock in profits or to remove a bias from an earnings play and most commonly is to avoid a directional bias when selling premium.
Delta neutrality is a position or portfolio that has overall delta near zero. It can be established with offsetting positive and negative deltas. There are several ways we can make our portfolio delta-neutral including the use of stocks, options and futures.
When using stocks to balance a position to being delta neutral we start with the simple concept that each share is 1 delta. We can add (subtract) deltas by buying (selling) shares. That means: if our AAPL position has -57 deltas, we can become delta-neutral by purchasing 57 shares of AAPL.
We can also use stock to create a delta neutral portfolio. The first step is to beta-weight our portfolio to the underlying we will use to hedge our portfolio. That is usually the S&P 500. We then beta-weight to SPY as it is the most liquid underlying that tracks the S&P 500. Then, if our portfolio has +114 deltas when beta-weighted to SPY, we can neutralize our portfolio deltas by selling 114 shares of SPY.
The dough portfolio tab shows the beta weighted SPY deltas on all positions. The portfolio shown in the segment had a current SPY weighted delta of 56.48. We could neutralize our portfolio deltas in the short-term by buying the Sep 212 put or selling 2 Sep 215 calls in SPY. For the long-term, we’d short 56 shares of SPY.
We can also use futures Each futures contract has a unique delta value. The emini S&P 500 contract has a delta of 50 for each contract (and a table shows that other futures and their deltas). We can sell 1 emini and reduce the delta to 6.48.
We can also use options Depending on time to expiration, volatility, and distance from at-the-money, options will have varying delta values. We can add or subtract deltas by buying calls or selling puts (and vice versa) to adjust the portfolio to the desired delta.
Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for an excellent primer on how to use different instruments to achieve delta neutrality.