What is Delta Neutral?
A delta neutral is a type of portfolio that seeks to combine positions on different holdings so that the overall value of the portfolio remains within an acceptable range, even if some of the assets should experience a downturn. The idea is to balance the gains, or positive deltas, with the negative deltas so that the portfolio retains a certain level of value. In order to accomplish this task, it is often necessary to diversify the investments involved so that the portfolio remains relatively stable even in the face of shifting market conditions.
Achieving a delta neutral portfolio requires managing to achieve a careful balance of the assets that are held. There are a number of combinations that may be used to create and maintain this situation. For example, choosing to buy a certain number of call options and balance those purchases with the acquisition of a certain number of put options will result in arriving at the delta position of zero, or delta neutral. Arriving at this state can require using just about any type of investment, including futures contracts or stocks.
The process for a delta neutral tends to work better in markets that are undergoing some degree of volatility. This approach is more difficult to utilize effectively in markets that are currently somewhat flat. While the market does not necessarily have to be demonstrating some sort of obvious trend, some amount of activity in various directions does actually aid in creating the degree of tension that helps to keep the assets in the portfolio within a certain balance. When the mix of financial securities is balanced properly, it is relatively easy to compensate for losses with one asset or group of assets with the gains earned with a different asset or group of assets.
One of the chief benefits of a delta neutral portfolio is that the overall value of the collective assets remains within a specified range even if individually those assets undergo some type of increase or decrease in value. Since there are always assets that help to offset the changes, the value of the portfolio remains constant and as such is capable of generating a constant or steady return. When hedging is used as one of the ways of achieving this state, care must be taken to monitor market changes carefully, since those hedged securities may or may not perform as anticipated. When this happens, the balance within the portfolio may be disrupted, effectively negating the delta neutral status.
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