Steve: I enjoy reading your articles and they are very informative. How is a delta-neutral strategy implemented, and are there any guidelines to ensure that it's successful? Thanks, --S.R.

To avoid putting the cart before the horse and discussing the intricacies of delta-neutral trading strategies, I'd first suggest you check out two previous

Options Forum

columns,

Facts About Delta, Part One and

Part Two.

Now here's what Hollywood might call the "high concept," a single-sentence summary of a delta-neutral position: The sum total of all existing options positions at one specific price, at an exact moment in time, is essentially like having no position at all.

As the name indicates, a delta-neutral strategy is often used by investors who don't necessarily have an opinion about the direction of a stock or the market, but want to establish a position from which they can react and realign their assets, hopefully in a profitable fashion, to any ensuing changes in the underlying elements.

Of course, things change and get much more complicated once elements like time and price are put in motion. For this reason, it's often considered a "dynamic trading strategy," and can be quite labor-intensive.

To maintain a delta-neutral, or perfectly hedged, position requires constant monitoring and adjustments. For example, if you own 100 shares of XYZ and can't just sell two at-the-money calls with each having a 50 delta, consider the position hedged and walk away. But this is just the beginning: As the price of XYZ moves through time, the delta is affected and you'd need adjustments to bring the position back to neutral.

There are two basic types of delta-neutral positions: one where delta increases as the underlying price rises (or declines) -- this is considered "being long curve;" and the other position where delta decreases as the price rises (or declines) -- this is "being short curve." Put another way, a long curve multiplies the bet as the price moves, while a short curve responds to a price move by increasing the bet (and risk) against a price trend continuing.

Like many concepts with options trading, whether it makes sense being long or short the curve comes down to implied volatility and your perception of it. A straddle (buying or selling a put and call with the same strike and expiration) provides a simple example for comparing these opposing sides of the same delta-neutral position.

If you think implied volatilities are too high (or the options are expensive), you might choose to go short the straddle, creating a short curve position. On the other hand, if you think the option's price doesn't reflect, or underestimates, the expected price move of the underlying contract within the option's life, you might decide to buy, or go long, the straddle.

As the price, time and volatility change, you need to reassess your position in terms of whether each variable still accurately reflects your suppositions. For strict delta-neutral trading to be profitable, you must be able to consistently identify and capitalize on options you think are mispriced. This is extremely difficult, even for full-time market makers and professionals traders.

A more realistic application of delta-neutral trading would be to allow the position to become "unhedged" at certain price and volatility levels that you think represent good purchase and sale points.

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to

steve.smith@thestreet.com.