Diversification or Delta Neutral?

Kimber wrote an interesting post regarding diversification. BTW Kimber, no idea where you got the idea that women can’t trade.

It has me thinking, do you diversify or do you become delta neutral? For those wondering, delta is one of the Greek letters in option trading, and it implies risk neutrality.

The question is what do the big traders recommend? Without knowing a hundred percent, they would probably recommend delta neutrality. I myself trade for the most part risk neutral (not completely delta neutral). Risk neutral means regardless if the security goes up or down I win!

Now comes the question, if delta neutral and risk neutral means I win regardless of how the security does, why don’t you trade delta neutral? Easy answer, I spent five months tweaking and creating my spreadsheet/program that finds the best times to buy and sell securities. And I still don’t know what I am doing.

Delta neutrality requires that you read books like, Investments (136 USD) and Options Futures, and Other Derivatives (157 USD). It is tough reading for me and I have read and re-read many parts of John Hull’s book. Though I do like the results as for the past month I have not lost any money. Even when companies like EBay went against me in a major way. It was amazing to see when EBay was slammed my portfolio was still in the positive. Had I made a couple of tweaks in software I could have traded that opportunity and made a healthy profit. The cost of delta neutrality is a risk premium (like car insurance) though I can live with that.

It is interesting in that I prefer being delta or risk neutral because I get deer in the headlight syndrome. Last year I was day trading and lost quite a bit of money (all of the losses ate into my gains not capital), but it startled me on how easy it is to give up gains. Trading really is about easy come, easy go. I stopped trading and started to think about trading and stumbled on delta or risk neutrality.

I personally don’t believe in diversification, but that is my personal opinion.  I feel if you are truly diversified then you might just as well buy an index because I doubt your returns would be higher than the index.

So why does Cramer and co talk about diversification? Simple, delta neutrality trading is a software task and is all about the numbers. It’s not about watching a moving average or oscillator. Its about number crunching. My software is not 100% compliant to a delta neutral environment (have not implemented all of the calculations), and that is why I call it risk neutral. Though I can say one thing, if you are willing to take the time to figure out the Greeks it could be worth your money.