Market Direction and Delta-Neutral Trading

Professional options traders think in terms of spreads, and they hedge themselves to stay neutral on the market's direction. The direction of the underlying stock is less important to them than the volatility of the options (implied volatility) and the volatility of the underlying stock (statistical volatility).

These professional options traders also let the market tell them what to do. They recognize the market is saying that the appropriate strategy is to sell premium when option volatility is high. Conversely, they understand the market is saying that the low-risk strategy is to buy premium when implied volatility is low.

The most difficult aspect of delta-neutral options trading is learning to stay focused on volatility. The reason it's psychologically hard to trade on volatility considerations is because it's natural to look at a price chart, draw conclusions about future market direction, and be tempted to bias your positions in the direction you feel prices will move.

However, the point of neutral trading is that you want to make money based on how accurately you forecast volatility, and you don't want to run the risk of losing money by forecasting the market direction incorrectly. That's why you should initiate your spreads delta-neutral. It's also why you should adjust them back to neutral if they later become too long or short. This brings us to the second most difficult aspect of delta-neutral options trading: acting without hesitation when the market tells you to act.

If your position becomes too long or short, you must mechanically adjust without hoping for price to move in the direction of your delta bias. While it's natural to want to give the market a chance to go your way, the fact of the matter is that the market has already proven you wrong, so it would only be wishful thinking to expect it to suddenly move the way you want.