Simple strategy 1: trading delta

You aren’t limited to trading a single option at a time. This means that options open up the possibility of many types of trading strategy, using a combination of calls and puts.

These are known as spreads, and they involve both buying and selling options simultaneously. Spreads can help you make money even when the market is static. One of the most popular spread strategies is trading delta, or delta spread.

As we saw in the last lesson, delta is the ratio that tells you how much an option’s price moves for every point of movement in the underlying asset.

Delta is a measure of how movement in the underlying market will impact the price of your option.

Delta spread

Using a delta spread can be profitable when markets are showing little or no volatility, and you don’t expect the price of an asset to change.

You may be able to set up a delta spread to make a small profit if the underlying asset does not change widely in price. However, larger gains or significant losses are possible if the asset does the unexpected and moves significantly in either direction.

With delta spread you establish a delta-neutral position by simultaneously buying and selling options in proportion to the neutral ratio. In other words, the positive and negative deltas offset each other, so that the overall delta of the assets in question totals zero.

The most common delta spread is a calendar spread. This involves constructing a delta-neutral position using options with different expiry dates.

In the simplest example, you simultaneously sell near-month call options and buy call options with a later expiry in proportion to their neutral ratio.

Since the position is delta neutral, there will be no significant gains or losses from small price moves in the underlying security.

However, as the near-month calls lose time value and expire, you should be able to sell the call options with longer expiry dates to gain an overall profit.

What is the risk?

With a delta spread the maximum loss is approximately limited to the premium paid, but can increase if the underlying has a large move and the delta of the options changes.

Should you be trading delta?

So is the time right for a trading delta? Ask yourself: is the asset price static? Does it look as though it could remain so for the period you want to speculate on?

If the answer is yes, if might be time to look at a delta strategy.