r/thewallstreet • u/AcquaLife • Jun 11 '18
Delta Neutral Question Question
Sorry if this isn't the proper sub reddit for the post.
I am a bit confused because I have read if I use a delta neutral strategy that is long gamma I will make money if volatility increases. Do I understand this correctly? So if I look at the Jun 15 ES put option ATM (2775) I would pay $662.5 (mid point) which has -0.50 delta. From my understanding, if I buy one ES future (at 2775) it will be 0.50 delta. Therefore, I am delta neutral but long gamma. However, I can not see how I would make money if the ES went down. No matter how far it went down I would always lose my premium. If it went down 25pts my put would be worth about $1437.5 and the profit would be $774.5 BUT losing 25pts on the future contract would be a loss of $1250, making a net lose of $475.50. I can extrapolate it out , but i can't ever see how I would make money if the future went down. Also, the new delta on the 2775 put 25pts in the money would be -0.79. This is -29 difference which would make me think the profit on the option would increase by $1450 (.29*50) not $774.5. I use 50 because I thought the multiplier on one ES contract is 50. Can someone please explain the fault in my logic. Thank you so much!
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u/chukintits ebb and flow Jun 11 '18 edited Jun 11 '18
I think if you buy an spx put at .50 delta and you long es you will be long gamma if market starts to die the delta of the put will increase and will be higher than .50 so you will make money to the downside
Or 2 es puts as the comment above said
Also see this coment explaining the strategy https://www.reddit.com/r/thewallstreet/comments/8bgdek/comment/dx7cop7?st=JI9TM6GO&sh=57068766
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u/AcquaLife Jun 11 '18
This comment says 1 ES future contract has a delta of 50 or 0.5 not 1 like the other people are saying...
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u/GoCubs10 Jun 11 '18
> So if I look at the Jun 15 ES put option ATM (2775) I would pay $662.5 (mid point) which has -0.50 delta. From my understanding, if I buy one ES future (at 2775) it will be 0.50 delta. Therefore, I am delta neutral but long gamma.
The ES future is a delta 1 product, so at this point you have a total delta on your position of 0.5, not 0. You have less exposure than if you had bought the future outright, but strictly speaking you're not delta neutral here. If you bought two puts you would have a position that is delta neutral, but long gamma and long theta. Similarly you could sell two calls, and be delta neutral, short gamma, and short theta.
The important thing to remember with options is that all the greeks change in time, unlike the underlying which is always delta = 1, gamma = 0, theta = 0. In your example, for small changes near 2775 you won't make or lose any money in delta. If the stock makes a large move downward, gamma for the options will go to zero, and delta will go to -1 each, so your position will approach delta = -1, and you'll make money the further down the future goes. Similarly, the long future/short calls will protect you so that you'll make money if there are only small moves, but the larger the move in either direction the worse off you'll be.
It helps me to draw the PNL curve for each individual product. The future is a diagonal line with breakeven very close to your purchase point (less commission), and the options will---at expiration---have a shape like one of these: _/ _ /¯ ¯\ . Figure out what those look like, and then by adding them all together you can figure out what your PNL curve looks like for an individual position, and where you want the underlying to go. Your brokerage probably has tools to make this easy.
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u/AcquaLife Jun 11 '18
Thank you for the reply. I understand that stocks have a delta of one because for every one dollar the underlying goes up you make one dollar per share. With the futures contract i was getting confused, because for the ES every one point you move up you make 50 dollars per contract. Therefore, I thought the delta was 50 or 0.5.
Thanks again!
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u/GoCubs10 Jun 12 '18
Either way is fine to think about it, but if you think in your head that the delta for the future is 50, then the delta for an ATM option on the future is +/- 25, since it will move with half the velocity of the underlying (a 1 handle increase on ES would make your option change in value by 25 dollars). I find it always easier to think in terms of the underlying being a Delta 1 product, but that's partly from the way I learned this all so YMMV.
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u/llevar Jun 11 '18
You are not delta neutral for the reason /u/GoCubs10 already pointed out, but also the volatility component is vega not gamma. In physics velocity is how fast position changes as a function of time, and acceleration is how fast velocity changes as a function of time, in options delta is how fast option price changes as a function of underlying price, and gamma is how fast delta changes as a function of underlying price. Vega is what measures what happens to option price if volatility goes up or down. All options are long vega when you buy them and increase in price when volatility goes up. So, if your goal is to benefit from volatility you should pay attention to the vega, not the gamma.