A long straddle is a commonly used options strategy that can take advantage of markets moving either up or down before the options expire, involving the purchase of both a call and a put of the same strike price and expiration date on the same underlying. It is a directional bet, but initially it is actually delta-neutral - that is, it's value will not change much given small movements in the underlying asset.
The options "Greek" known as delta measures how much its price will move in relation to the changes in an underlying's price. It's the ratio that compares changes in an option to changes in the price of the underlying asset. But when you buy an at-the-money (ATM) straddle, the call option is +0.50 and the put option is -0.50, making the delta of the combined position zero.
- A straddle is an options strategy involving the purchase of both a put and call option for the same expiration date and strike price on the same underlying.
- The strategy can be profitable when the stock either rises or falls from the strike price by more than the total premium paid.
- Even though it is effectively a directional bet, because it is agnostic to which direction and because it involves both an ATM call and put, it is also delta-neutral at initiation of the strategy.
Delta of an Option
Let's look at delta a little closer. As an example, if an investor buys the +0.50 delta call option, this tells you that if the underlying stock price gains $1, with all else equal, the value of the option will gain $0.50. So, if the option cost $2.20 and the stock was trading at $63.00, if the stock rises to $64, you can expect the call option to be worth $2.70. Likewise, if they stock instead fell to $62.00 per share, the call's value would decline to $1.70.
The delta of a call option can range from 0.00 to +1.00. The delta of a put option, on the other hand operates in reverse since puts increase in value as the underlying asset falls. Put deltas can range from -1.00 to 0.00.
Thus, whenever an investor buys calls, they are long deltas. On the other hand, when an investor buys puts, they are short deltas. Deltas of positions involving multiple options are computed by taking the weighted average of all individual option deltas held, positive and negative.
What Is a Straddle?
A trader will profit from a long straddle when the price of the security rises or falls from the strike price by an amount more than the total cost of the premium paid. Profit potential is virtually unlimited, so long as the price of the underlying security moves very sharply. Investors tend to employ a straddle when they anticipate a significant move in a stock's price but are unsure about whether the price will move up or down.
What Are Delta-Neutral Positions?
A delta-neutral position is a position that is created with positive and negative deltas – which are offsetting – to create a position that has a delta of zero.
For example, let's say that a trader buys at-the-money $100 calls and simultaneously buys at-the-money $100 puts. As a result, the trader's position is long the $100 straddle. Generally, the at-the-money calls have a delta of a 0.5, and the at-the-money puts have a delta of -0.5. If both these options are purchased, the deltas offset each other to make it a delta-neutral position.
What's important to recognize about a strategy like the straddle is that while it is delta neutral at first, it gains or loses net deltas as the underlying moves. This is because a straddle is also a long gamma position. Gamma is the rate of change in an option's delta per 1-point move in the underlying asset's price, so as the underlying moves up, the call's delta gets larger and the put's delta gets relatively smaller - meaning you become more and more "long" the market as the stock rises. Similarly, if the stock falls, the call delta gets smaller but the put delta gets bigger, making you "shorter" and shorter the market as it falls.