Yesterday, after the market closed, I went to my Twitter account and, like always, I quickly pass through the feed using my smartphone and the majority of pictures published were charts with support/resistance lines, Fibonaccis, etc. Most of them also with several indicators, some of them were not recognized by me… trying to predict the market or stock next movement.
To be honest, I also tried in the past to learn technical analysis and how to use some indicators. Like many, I started trying to predict the next market or individual stock movement. Soon, I understood it did not work for me. I realized after some losses that I am not a good market forecaster!
After that bad experience, if I wanted to continue to trade, I had to come up with another type of trading that would take out the equation the direction prediction. This means that my “trading dogma” would be: “the 2 most probable outcomes for next day close are (both having an equal chance to happen) either the market moves up or down!”.
Delta Neutral trading avoids direction guessing
When I am trading with my community, I am trying to keep things as simple as possible. I am trading options exclusively due to their leverage and flexibility on adjustments and strategies made possible. I have a set of strategies that I developed which I apply to a small number of instruments. In fact, I am only trading SPY, QQQ, and VXX! I do not lose time searching for stocks that met certain criteria to enter trades.
When trading, my goal is to manage risk from each trade as well as the overall portfolio. And not looking at charts. They tend to deviate your attention from the essential: your portfolio and its risk!
One book that I can suggest that explores the concept of Delta Neutral trading is “Option Volatility and Pricing” by Sheldon Natemberg. A must-read if you want to move your trading to the next level.
Delta Neutral trading can be used to explore extremes in implied volatility. The goal is to enter a position that starts in a Delta Neutral (Delta near 0) and adjust accordingly (with stock or verticals, for example) as long as underlying moves to maintain Delta neutrality. Please note that not only when the underlying price moves it will impact Delta, but also when options Implied Volatility change or time passes (options time decay). If we keep Delta under low value and Volatility changes according to our predictions we end up profiting from this type of trade. For example, if we predict that IV will move up in a certain asset, we can buy a Straddle or Strangle (Vega positive trades) that, under Delta, neutrality adjustments may gain if the underlying moves in either direction.
But, this is not so easy to apply because, with options, everything varies and one key issue is time value! As time passes, in the given example, we are buying options, and hence the position will lose money due to options time decay. The strategy described above included only long options that will produce high negative Theta! If the increase in volatility is not fast enough, the position will lose from time decay even if there were an increase in options volatility.