There have been a couple of questions on delta neutral trading both on the forum and via PM; I'd promised to start a thread, but have been slack thus far, so here we go.
Feel free to ask questions as we go along.
But first we need to understand a couple of Greeks, starting with "delta" itself.
The short version:To explain it further, we need to understand that all trading instruments have delta. Delta is expressed as a fraction of 1 or -1 (Except if discussing "position delta" which we'll go into in a minute), therefore any derivative's rate of change is that fraction of change compared to the long underlying.The amount an option's price will change for a corresponding one-point change in the price of the underlying security.
So if we're talking stock and stock options, we know that the delta of long stock is 1. Another way of looking at it is that for every dollar the stock goes up, we make one dollar... easy.
Therefore if we look at short stock; for every dollar the stock goes up, we will lose one dollar, so short stock has a delta of -1.
Options, in the vast majority of cases have a delta of some fraction of 1 or -1.
An ATM long call has a delta of approximately 0.5, so if the underlying stock goes up $1.00, then theoretically the option will go up by $0.50. Similarly, an ATM long put has a delta of approximately -0.5 and will lose $0.50 for every dollar the underlying rises.
When you write (short sell) options, the delta is reversed, just like if you short sell a stock; short calls have -delta and short puts have +delta.
Position delta (sometimes referred to as deltas) is the sum of all the individual deltas in a position.
So if you own 100 shares in a stock, your position delta is 100. Or it can be stated that you have 100 deltas.
If you own one ATM call contract (presuming a contract size of 100 options), your position delta is ~50, or 50 deltas.
to be continued.