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I am setting up a delta-neutral position using options only. My goal is to trade implied volatility having always a delta-neutral position. My question is, is there any difference if I do it with at the money options, in the money options or out of the money options?

Since it's a delta-neutral position, I assume it's equivalent to set up a position with out of the money options or in the money options. Am I wrong?

i.e Is it too dangerous to buy OTM options even if it's delta-neutral?

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  • whats the danger? if you buy OTM options your max loss is 100%, this is the least risky thing you can do with options.
    – CQM
    Dec 21, 2016 at 0:53
  • Yeah true. But what I am refering to is the probability of loss. Is there a high probability of entering into a winning trade if you are betting for a volatility increase (while maintaining delta neutrality) if you use at the money options? i.e is an +1% increase in volatiliy for ATM options will be equivalent in percentage terms for out of the money options??
    – Luis Cruz
    Dec 21, 2016 at 1:26
  • thats what Vega is for. You will probably be better off looking at how vega trading strategies work, for your answers and insight
    – CQM
    Dec 21, 2016 at 7:37
  • AFAIK out of the money options are not all that 'risky', because, basically, they are cheap (if far OTM) and you almost certainly will lose whatever you put in them, because you'll never make the strike price. All you have is time value, and that's going to vaporize by expiration. They are about the least variable investment out there. By example, put options for oil (Aug 2017) with a strike price of $42.00 a barrel are way out of the money, and cost $0.82 a barrel. Cheap, but you'll probably lose it.
    – user11599
    Jan 23, 2017 at 0:41
  • You're not looking at the big picture. Yes, OTM options have lower sensitivity to volatility than ITM but since you are delta neutral, you are going to buy more OTM's than had you bought ITM or ATM. So there is a multiplicative effect. For example, with 100 short shares, you could buy 2 ATM calls (+50 delta each). Or you could buy 3 OTM calls with a delta of +33 each. If XYZ rises, you're going to get more bang for the buck from the 3 calls via delta and price. Make adjustment with the underlying, not the options, because B/A spreads are narrower and you can fine tune delta better.
    – Bob Baerker
    Oct 14, 2018 at 22:00

2 Answers 2

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With a delta-neutral position using options only, you are essentially trading volatility. OTM options have a lower sensitivity to volatility (vega) than ITM options do, so your expected return will be less with ITM options (but the risk is lower, too).

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There is nothing inherently dangerous about an OTM option position except there tends to be more liquidity (and narrower spreads) around the ATM options.

Also the delta will change as the underlying fluctuates, so you might have to make delta adjustments by buying and selling more options or underlying securities to keep it neutral.

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