Results of Delta Neutral Trades

Let’s do the post mortem on yesterday’s trades.  We sold back the options at 3:40 PM when the underlying stock, JP Morgan Chase (JPM) was around $25 per share.  JPM had dropped from $27.28 during the day.  That is a loss of 8.4% If the market had liked what the Treasury Secretary had to say, the stock could very well have risen by the same amount.  The only way to play a large move on either side is with options.

That’s why we love them so.

The Straddle

Our cost to purchase each straddle with a strike of 27 for both the put and call was $3.73.  We sold the put for $2.46 and the call for $0.64 for a grand total of $3.10

So this trade was a loser by $0.73 or 19.6%

Not very good.

The Strangle

We bought a 29 call and a 26 put for a total cost of $2.32.

We sold the call for $0.27 and the put for $3.08 for a total of $3.35.

So this trade was a winner by $1.13, or 48.7%, for each strangle.

Quick and Dirty Analysis

Why was the strangle a winner and the straddle a loser?

All the volatilities move pretty much together.  The difference in implied volatility across different strikes, called the volatility smile, is small compared to the volatility itself.

So the difference has to do with how the deltas change.  At the start, the straddle deltas are close to ½ since the options’ strikes are close to the stock price, $27.28   As JPM drops through the day, the put delta increases to close to 1 and the call delta drops to perhaps 25% Remember, the delta tells you how the value of the option changes with the change of the stock price.  So say on average the put delta = ¾ and the call delta = 3/8.
Since the call delta drops as much as the put delta increases, there is no profit.

The strangle, on the other hand, had much larger moves in the put delta compared to the call delta.  Since we made $1.77 on the 26 put and JPM lost $2.28, out delta = 1.77 / 2.28 = 77% while the call lost $0.74 so its delta = 0.74 / 2.28 = 32%

Since the price of JPM dropped through the put strike of $26, the delta went up rapidly, while the call delta didn’t fall as much.