Wednesday, July 3, 2013

Why Premium Sellers Typically Short Delta

Yesterday I tuned into "Where do I start" @ TastyTrade.com. And during this 15 min segment Tom explained to Case why premium sellers like himself are typically delta short. In a nutshell it has to do with the fact that as a premium seller you are short volatility which rises in in a down market, so being short delta helps offset that a bit when markets move lower.

Put another way, first you have to realize that volatility and market direction typically have an inverse relationship. When the market goes up volatility typically falls and when the market goes down volatility typically rises. As a premium seller you are selling or shorting volatility, so in a vaccuum your short vol position (short option) will make money as the market rises and lose money as the market drops. However we do not live in a vacuum and there are other factors that move your position's P&L.

Delta is the equivalent position in the underlying and gives you an estimate of how much your P&L will move up or down for each $1 move in the underlying. This is why you can be short premium and when the market goes down, assuming you are also short delta, your P&L is not down nearly as much as your short vol or vega may suggest.

If you are interested in learning more check out the where do I start video on the TastyTrade.com website. It was uploaded on 7/2/13.

Good Luck Trading!

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1 comment:

  1. With the high volatility that we have seen come back into the market since October of last year, it seems like a lot more opportunity has opened up.

    Oil seems to be the best opportunity to be selling long premium in right now.

    I am long oil and short SPY.

    Cheers!

    ReplyDelete