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As a retail trader, does it make sense to hedge an option position by taking an opposing position in the underlying?

If I buy a long call and short an equivalent number of the underlying so that the position delta =0, how can I ever make money?

It seems like I have no directional risk and also no profit opportunity. The move in the option and the underlying will always cancel each other. I understand how this makes sense for a market maker who makes money on the bid ask spread, but does this make sense for a retail trader?

  • No, unless you think you can beat banks at that game, which is very unlikely... – assylias Oct 23 '14 at 21:24
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    If you neutralize delta, you still have gamma and theta for possible income. Not for a beginner. – Optionparty Oct 23 '14 at 23:28
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Delta hedging is not the same as being delta neutral, what you just described is being delta neutral.

There exist reasons for a retail trader to be conscious of delta when choosing an option.

  • Thanks. So delta neutral for retail trader is not advisable, but delta hedging is? Sorry I mixed up my terminology, I am still learning – Victor123 Oct 23 '14 at 20:48
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    Delta neutral is just one way to delta hedge. delta hedging can comprise have all sorts of other strategies. For instance, maybe you computed the delta of your leveraged futures position, and you want to hedge with something that has a higher or lower delta. That is still delta hedging. – CQM Oct 23 '14 at 21:08
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The answer is that the trader is hoping to profit from a potential rise in Implied volatility. He is isolating his exposure to IV only and mitigating his risk to the directional move of the underlying by hedging with the underlying.

Basically, his delta is neutral. His gamma is positive and a potential source of profit, and his theta is negative which is a potential source of loss.

He hopes that the profits from long gamma will overcome the loss from the short theta. he achieves this by actively gamma scalping to remain delta neutral over the life of the option.

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