Hello options traders, in a previous article I discussed Delta, and how to use it to make profitable trades. What many traders don’t consider is that your delta doesn’t have to stay consistent throughout a trade. Many professional options traders manage their positions in order to add or decrease delta. Let’s discuss some methods and benefits of managing the delta of positions before they expire.
One downside to utilizing high probability of profit (POP) trades, especially credit spreads, is that they can turn very ugly if the underlying stock moves against you. The maximum loss in high POP trades is often much larger than the maximum profit. Most of the time, these trades work out great, and are reliable and consistent. What can we do to minimize our losses on a losing credit spread?
Never Follow Your First Instinct
It is the first instinct of many traders to panic and close the position when they see a large loss. This is a big mistake. Holding onto to profitable trades hoping for more profit and closing losing trades while they are still losers will result in poor returns. So, should you just hold onto a losing position and pray the stock moves in your favor? Of course not! It is important to consider that in addition to closing or holding, you can add more options to your positions.
Example Of How To Trade Delta Focused Options
Lets imagine you’ve opened up a put credit spread on a stock. Some bad news comes out, and the stock plummets. You are now at a loss, and it appears that the stock shows no sign of stopping its fall. What can you do? Well, instead of closing, you can simply reduce your delta. By nature, put credit spreads have a positive delta. To reduce your delta, you simply have to enter an option position in the same underlying with a negative delta. This could be selling a call spread, buying a put spread, or even simply buying a put. I personally recommend selling a call spread, therefore creating an iron condor. This will help to reduce your losses should the stock continue to plummet. Just ensure your positions delta is overall positive, that way if the stock recovers you will make back a portion of your money.
Keep in mind that adding more options to your position does increase your max loss. It doesn’t eliminate the potential for further losses, it simply helps your position if the stock continues to move against you. It does increase your maximum potential profit as well, especially if you go the credit spread to iron condor route.
Increasing Delta Is Another Way To Manage A Position
Reducing delta isn’t the only way to manage a position. You can also increase your delta if you believe the stock is going to reverse, rather than continuing to drop. This is achieved in the same way that reducing delta is, but instead you simply add more options with positive delta. This way, it will require a smaller upwards correction for you to break even. I would advise against this in most cases, as if you are wrong you will lose even more than if you just held the position. As always, there is always a time and place for certain strategies. Keep your personal portfolio goals and risk toleration in mind.
Delta in individual positions is one way to manage your delta. Options traders should also keep in mind the delta of their overall portfolio. Your portfolio delta is the sum of the delta of every option in your portfolio. If you want to collect credit and use theta as your main driver of profit, you should try to keep your delta close to zero. While you may have temporary success timing the market and making big gains, nobody can time the market forever. If your portfolio delta is very high during a bear market, you can say goodbye to your profits. Keeping your delta close to 0 ensures that you can collect money from time decay and directional moves will have less impact.
Keeping Delta To Zero
So what is the best way to keep your portfolio delta 0 while making money trading delta options? This is up for debate, but uses the same principle as editing position delta. If your portfolio delta is very negative, add a long position with positive delta. One strategy I like to employ when my portfolio delta gets very high is selling a call spread on an index. I choose an index that contains the underlying stocks my long positions are associated with. For example, if I’m long a lot of tech stocks, I’ll sell a call spread on the Nasdaq index, QQQ. If I’m long a lot of retail stocks, I’ll sell a call spread on a retail ETF such as XRT. Do some research to find out what ETF’s and indexes include your longs/shorts in order to reduce your delta and hedge your bets.
Even if you are an options seller who relies on theta, it is important to study delta. Delta is not important to directional trading exclusively, and it can be used to edit positions and hedge your bets. Stay profitable and happy making money trading delta options.
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