A common strategy by ‘professional‘ option traders and strategists is to buy a 60 Delta option to initiate a new trade. The reason I put quotes around the word ‘professional’ is because having a YouTube channel doesn’t necessarily mean they are a professional or someone you should listen to. That also applies to blogs, including this one! Do you own research and don’t just blindly accept what anyone says about option trading. With that disclaimer out of the way, let’s get to the analysis of comparing the performance of a 30 Delta option vs. a 60 Delta option!
Below is the risk profile of a SPY 60 Delta Call option as of today’s (11/12/2022) date. I could buy (1) Call for $1,485 ($14.85x$100). In all of the examples below I’m using the Dec16 monthly expiration.
Below is the risk profile of a SPY 30 Delta Call option as of today’s (11/12/2022) date. I could buy (2) Calls for $932. (2) of the 30 Delta Calls equals 60 Deltas of directional risk, same as the 60 Delta option.
Let’s say that tomorrow the SPY opens 2% lower. Ouch, wrong direction! If that happens the 60 Delta position will lose approximately $442. If I was trading with a stop (I always do) then I would’ve likely exited the trade with a $442 loss.
Let’s again say that tomorrow the SPY opens 2% lower. If that happens the 30 Delta position will lose approximately $395. Not great but definitely better than the $442 loss on the 60 Delta Call.
What about if the $SPY opens 2% higher tomorrow? The 60 Delta Call will have approximately a $512 profit.
If the $SPY opens 2% higher tomorrow the (2) 30 Delta Calls will have approximately a $560 profit. $560 is better than $512, wouldn’t you agree? 😀 Also, the (2) 30 Delta Calls cost a total of $932 to buy so that $560 profit is a 60% return on initial risk. The 60 Delta option had a 34% return. 60% is better than 34%, wouldn’t you agree again? 😀
Now, here’s where the real difference between my zero cost Delta Hedging strategy and the ‘professional‘ traders buy and hold or buy and sell it if the trade makes a certain percentage return! Let’s say their threshold for exiting a profitable trade is a 30% gain. They’d sell the Call at tomorrow’s close having made $512. Then the whole process starts again the following day taking around $1,500 of risk and trying for another 30% gain. If SPY opens 2% lower on that second trade they’ll lose $442. That’ll leave them with a net $70 profit for taking around $1,500 of risk. That’s better than a loss but it’s no fun giving back just about everything you’ve made on a previous trade especially if the day after resumes the uptrend and you’ve exited out of a position! If they had instead used the zero cost strategy they would have sold the 400 Call for the same price they paid for the 393 Call to create a $7-wide (393/400) Call Vertical spread for a net zero cost. That removes all of the initial cost of the position! No need to exit the position to protect against SPY turning lower and losing the open profit as well as potentially losing all of the initial $1,500 risk. You could lose the open profit but the initial risk has been eliminated.
Another advantage of initiating a trade with (2) 30 Delta options vs. a single 60 Delta Call is the reward to risk ratio of carrying the trade forward. The reward to risk of holding the 60 Delta Call after Delta Hedging it to net zero cost following a 2% gain in SPY is just .44:1. In other words, you’d be risking $487 to potentially make an additional $213 if SPY continues to trend higher. Below is the risk profile of the (2) 30 Delta Calls after it’s been Delta Hedged into a net zero cost Vertical spread.
If SPY was 2% higher tomorrow the 30 Delta Calls could reach zero net cost by selling the 421 Calls for the same price paid for buying the 414 Calls to initiate the original trade. That would result in a $7-wide (414/421) Call Vertical spread for a net zero cost. That removes all of the initial cost of the position! That $7-wide spread is the same width spread as the 60 Delta Calls so where’s the big advantage of buying 30 Delta Calls vs. 60 Delta Calls to initiate the position? The difference is that I was able to buy twice as many 30 Delta Calls for less initial risk than buying a single 60 Delta Call! Now I would own (2) $7-wide spreads instead of just 1 and 2 is better than 1, wouldn’t you agree? 😀
There’s a way to actually lock-in a profit while increasing the maximum additional potential profit of a net zero cost Vertical spread by turning it into either a Butterfly or a Condor spread but that’s covered elsewhere in the blog so I’ll let you do your own research on that because this post is done!
Questions or comments? Leave them down below.