Should you construct complex trades with positive or negative deltas or, perhaps, with a zero delta?

Before tackling the topic, newbies might appreciate a brief discussion of deltas. Such a discussion can be found in last week's article. The most important idea is that delta describes how much a trade will benefit or be hurt by a price move.

Obviously, if it's your intention to construct a directional trade, you want deltas to lean in the direction that will fit your viewpoint. If you're bullish, you're likely constructing a trade that has positive deltas. If you're bearish, you're likely constructing a trade that is negative deltas.

NDX Call Credit Spread, OptionNet Explorer Chart:

First, I must note that the trades illustrated here are not suggested trades. I don't trade the NDX but instead was using this for illustrative purposes. My Options 101 articles are roughed out well ahead of publication, so all prices will be outdated, anyway.

The risk graph clearly shows that this is a bearish-to-neutral trade, benefiting by a drop in the NDX's price, a steadying in price or even a slight rise. Accordingly, the deltas are negative on the trade, at -6.15. The 100 multiplier has already been applied, and the trader knows that for a short distance, on this day, the trade will theoretically benefit about $6.15 for each one-point drop in the NDX. It will be hurt about that much by a one-point climb, as long as implied volatilities stay about the same.

The trade also benefits at expiration if the NDX has not climbed in price or climbs only up to the sold 3275 call, although a climb of that degree early in the trade would result in a big unrealized loss. Just because the trade can benefit at expiration doesn't mean that the trader shouldn't exercise good trade management during the trade.

With this trade and any directional trade, it's easy enough to determine which way you want deltas to lean, but what if you're constructing a so-called "neutral" trade, such as an at-the-money butterfly or calendar, or an iron condor centered near the current price?

Four-Contract, Near-the-Money Sept/Oct ATM Calendar:

This calendar was not quite centered over the current IWM price. Since the 104.5 strikes weren't available for SEP and OCT when this chart was snapped, a choice had to be made as to where the central strikes would be. The calendar leans a little to the positive delta side. Why might I want deltas to lean a little to the positive side if I were constructing a calendar?

The answer comes when we consider what happens when prices climb. Typically, when prices climb, implied volatilities drop. The calendar is hurt by a drop in implied volatilities. For many experienced traders, a "vol crush" is a dreaded event when calendar trades are open. Those interested in the Greeks of options trading can see the likely effect when they look at the vega of the trade: 17.45. (Note: Vega is not technically a Greek alphabet symbol, but it is still generally included as one of the "Greeks" of options trading.) Vega describes how much a trade will theoretically be hurt or helped by a change in implied volatilities. A positive vega means the trade will be helped by a rise in implied volatilities and hurt by a drop in implied volatilities. A negative vega means a trade will be helped by a drop in implied volatilities and hurt by a rise in implied volatilities.

A calendar's positive vega means it will be hurt when implied volatilities drop, an action that typically occurs when prices either steady or climb. Theoretically, setting it up so that it has positive deltas means that, in a rally, the deleterious effect of dropping implied volatilities will be at least partially offset by the delta-related gains from the price movement itself.

Butterflies and iron condors are negative-vega trades. They are helped by a drop in implied volatilities and hurt by a climb in implied volatilities. Implied volatilities typically climb in a downturn. Which way, then, would you want deltas to lean to partially offset any damage done by a climb in implied volatilities? Some traders like to set up their butterflies and iron condors so that deltas are a little negative. Theoretically, a drop in price will show delta-related gains to partially offset the deleterious effect of a rise in implied volatilities in a downturn.

These are simplistic explanations. A whole lot can happen to change what should theoretically be happening with certain price changes. Both vega and delta change when price movement is big or has extended across a period of time. However, these are useful considerations.

How negative should the delta be in a butterfly or iron condor, and how positive in a calendar if you're going to employ this technique? Again, these aren't directional trades, so the trader shouldn't lean too far with the deltas. With my butterflies, I don't like to have more than -5.00 deltas/butterfly contract, but I am infamous for paying more than some people to keep my profit-and-loss line as flat as possible. That cuts down my potential profit, but it's necessary for me due to some lifestyle considerations.

Now that I've explained all this, I'm going to thoroughly confuse traders. Many think-or-swim users have discovered that their butterfly deltas are less negative than other trade charting services show they are, and sometimes by a considerable amount. Put another way, the trade acts as if the deltas are more negative than think-or-swim analytics show it to be. What should you do if you want to lean a little negative on a butterfly, for example, but maybe you're leaning far more negative than you think? Test your trades, either through backtesting or simulated trades that you follow for a cycle or two on think-or-swim. See if they perform the way you think they should. Right now, although I want to lean a little negative on my butterflies, I'm constructing them and adjusting them so that they never end the day lower than +1 delta/butterfly contract. And, they're acting as if they're negative deltas. That may not be needed with other types of trades or trades closer to expiration. So, know what you want to do but also know your individual brokerage or charting service.