the  price  goesup, the trade is a winner. If the stock takes a nosedive, you are riskingyour proﬁts. If the price of the stock declines, you may lose your prof-its, and perhaps some of the original premium due to time decay.3. Adjust the position. There are several ways to do this. The idea is tocontinue  in  the  trade  while  simultaneously  capturing  proﬁts  and  re-turning the overall position delta to zero.
These three alternatives possess their own respective advantages anddisadvantages. Often the best choice can only be determined by hindsight.But  since  the  key  to  proﬁtable  trading  lies  in  assessing  the  availablechoices, learning the beneﬁts of adjusting can help you to become a moreproﬁtable trader.
Options  with  various  strikes  have  different  deltas,  and  these  deltaamounts change as the underlying asset’s price ﬂuctuates. The object ofthe delta neutral game is to keep your trade as close to zero deltas as pos-sible. When the next uptick changes the market you are trading, you areno  longer  neutral.  That  means  that  you  may  be  able  to  make  an  adjust-ment by purchasing or selling calls, puts, or stock shares to get the tradeback to delta neutral.
Adjustments are much easier to make when you have placed a tradewith multiple contracts. They enable traders to lower the overall risk ofthe trade, and in some cases, start the spread over again at a new price.If  there’s  a  proﬁt  on  the  table,  an  adjustment  can  allow  you  to  take  itand  still  keep  the  overall  risk  of  a  trade  low.  If  the  price  continues  torise, you can still beneﬁt from the bullish movement. Conversely, if theprice declines, there are ways to proﬁt from a reversal rather than lose.As  a  delta  neutral  trader,  I  have  often  found  it  proﬁtable  to  adjust  mystraddle positions.
Since  a  straddle  is  already  a  combination  trade  consisting  of  at-the-money (ATM) puts and calls, there are many alternatives by which adjust-ments  can  be  made.  All  adjustments,  however,  ﬁt  into  two  categories:adjusting with options or stock. The adjustments further break down intopositive or negative changes depending on what is needed to bring posi-tion delta back to zero.
Adjusting with Options
Straddles have a large theta risk because the time value of the options isconstantly declining, which results in lost premium. Since adding more op-tions increases the theta decay, you can decrease it by making adjustments
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through selling options that are already owned. If the price of the stockhas increased since the last adjustment, you can reduce the delta by sell-ing some of the calls and taking proﬁts. If the price of the stock declines,simply  sell  some  puts  to  increase  the  overall  position  delta.  Selling  op-tions provides an additional major advantage: You can put your cash backto work by investing in new positions.
The  number  of  options  to  be  sold  depends  on  the  overall  positiondelta in relation to the deltas of the speciﬁc options. All options are pro-vided  a  delta  relative  to  the  100  deltas  of  the  underlying  security.  If  100shares  of  stock  are  equal  to  100  deltas,  then  the  corresponding  optionsmust have delta values of less than 100. You can estimate an options deltausing Table B.3 in Appendix B.
Selling  options  does  have  two  basic  disadvantages:  commissionsand  slippage.  Most  traders  pay  a  certain  minimum  commission  whentrading  options—typically  $10  to  $30.  If  the  adjustment  involves  thesale of only one or two options, this can become a signiﬁcant amount.In addition, the bid/ask spread on options is an eighth or higher, some-times as much as a whole point. This can also have a detrimental effecton the proﬁtability of the position. Since you are working with a spread,it  can  be  difﬁcult  to  be  precise  with  adjustments  because  the  calcula-tions  involved  in  trying  to  pinpoint  the  price  at  which  the  contractshould be sold are often problematic.
Adjusting with Stock
Adjusting a straddle with stock is a fairly easy to understand process andusually less difﬁcult to execute. If the straddle becomes too delta positive(long),  shares  of  stock  can  be  sold.  If  the  straddle  becomes  too  short,stock  can  be  purchased  to  easily  adjust  the  delta.  The  calculations  ofwhen to make an adjustment are much easier: When delta gets to 100, asale of 100 shares of stock will bring it back to zero.
Commissions  on  buying  and  selling  stocks  have  become  so  low,thanks to the advent of online brokerages, as to hardly be of any concern.Many  online  brokers  will  execute  a  trade  for  less  than  $10.  The  bid-askspread  is  typically  a  sixteenth  and  the  savvy  trader  can  get  a  price  exe-cuted exactly when the trader wants.
Although selling options might appear at ﬁrst to be the best way tomake  adjustments,  for  the  reasons  just  mentioned,  many  traders  havefound  that  adjusting  with  stock  is  the  most  efﬁcient  way.  Option  soft-ware and spreadsheets can be produced that can very easily indicate allof the possible adjustments needed in the trading day, before the mar-ket opens.
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Adjustment Targets
There are three main triggers or targets that you might consider using tomake  adjustments  in  a  spread  position:  delta-based,  time-based,  andevent-based targets. Each one has a unique set of advantages and disad-vantages that can be employed to advance your proﬁtability.
Delta-Based  Adjustments The straddle is constantly monitored forits position delta. Using option software, you can watch how the price ofthe  stock  changes,  which  triggers  market  makers  to  change  impliedvolatility. In the process, the delta of your position is recalculated. Whenthe delta reaches a predetermined level—usually 100—you can adjust theposition by buying or selling stock or options to return it to delta neutral.Many traders do their calculations at the beginning of each day, identi-fying  the  exact  stock  prices  at  which  the  delta  will  change  by  100,  andplace orders to buy or sell stock at that point. This allows the orders to beplaced  in  advance  and  automatically  executed  at  the  proper  levels.  Thetrader  does  not  have  to  follow  the  stock  tick-by-tick  to  ﬁnd  the  adjust-ments; they will just happen.
The major advantage of this method is that it is exact and mechanical.The position never acquires more than plus or minus 100 deltas, thereby cap-turing proﬁts as they occur. You can also take advantage of intraday swingsin price. No judgment or decisions are necessary because the adjustmentsare automatic.
The main disadvantage used to be the time it took to do the calcula-tions. But technology rules the day. This process can be computerized intoa spreadsheet, even the number of trades that are made and the resultingcommissions.  But  another  disadvantage  rears  its  ugly  head:  Delta-basedelectronic trading does not allow for positions to spontaneously “run” ortake advantage of the higher deltas from a large move in the stock. This,however, is the type of directional risk that we are seeking to avoid.
Time-Based  Adjustments A simple method is to make delta adjust-ments according to a time schedule. At the end of the morning, the day, orthe week, a calculation is made to bring the position back to delta neutral.The major advantage is simplicity, but many opportunities for adjustmentsbetween the scheduled times might be missed.
Event-Based  Adjustments This  method  is  used  quite  frequently  toadjust  positions  that  would  not  ordinarily  be  adjusted.  A  special  eventmakes such an adjustment important in preserving proﬁts.
For  example,  the  release  of  an  earnings  report  increases  a  stock’smarket volatility. In fact, stock prices often run up or down in anticipation
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of the upcoming report, and if the report catches Wall Street by surprise,the stock might reverse direction altogether. In this case, just before thereport, an adjustment can be made to capture the proﬁts in the straddlethat have resulted from the preannouncement volatility increase and re-sulting move in the stock. By returning the straddle to delta neutral, youcan beneﬁt from a continued run, or even more important, from the rever-sal that seems to occur frequently around these reports.
For example, let’s say you have a straddle on a stock, with a strike of50. The earnings report will be on Monday, and the stock has moved to 60in  anticipation  of  a  great  report.  You  could  choose  to  be  optimistic  andhope that the report will be a surprise to the upside, and the stock will in-crease  even  more.  But  what  if  the  report  triggers  a  sell-off?  You’ll  loseyour proﬁts. If you do your delta calculations—sell some stock or optionsto  bring  the  position  back  to  delta  neutral—by  Monday  you  won’t  carewhich way the stock moves; you will beneﬁt either way!
Bottom line: Adjustments can be excellent ways to reduce your risk oflosing  hard-earned  proﬁts,  and  even  increase  them  further  by  beneﬁtingfrom reversals.
ADJUSTING LONG SYNTHETIC STRADDLES
You can create a long synthetic straddle by selling 500 shares of XYZ at$25 and buying 10 June XYZ 25 calls at $2.20. This is a perfectly hedgeddelta  neutral  position  that  enables  you  to  make  money  in  either  direc-tion (with calls to the upside and the short shares to the downside). Re-member,  as  long  as  you  use  long options—puts  or  calls—it  is  a  longsynthetic straddle.
I prefer to use ATM options because they have high liquidity and areeasy  to  work  with.  High  liquidity  increases  the  probability  of  proﬁt  andfosters better pricing because the price spreads are thinner. Price spreadsare the difference between the bid price and the ask price for which you,as  a  trader,  can  buy  and  sell  options,  futures,  or  shares.  As  an  off-ﬂoortrader you will typically buy at the higher price (the ask) and sell at thelower price (the bid). Meanwhile, ﬂoor traders typically make their moneyby purchasing from you at the bid, and selling to someone else at the ask,or  vice  versa.  In  other  words,  when  we  refer  to  price  spreads,  we  arereally talking about the bid and ask prices.
In  the  last  30  days  before  expiration,  an  ATM  option  is  actually  themost liquid option out there. Although ATM options have the highest liq-uidity, liquidity tends to taper off similar to a bell curve; the further out-of-the-money  or  deeper  in-the-money  you  go,  the  less  buying  and  selling
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occurs. The spreads become a lot wider. You can look at something that istwo strikes out-of-the-money and there could be half a point difference be-tween buying and selling it. This means that you are automatically downhalf a point in your position as soon as you initiate the trade. That’s why Ihighly recommend initiating a delta neutral trade by using ATM options tooffset stock positions. They are more liquid and should have a narrowerspread between the bids and asks (offers).
Let’s return to the long synthetic straddle example composed of thesale  of  500  shares  of  XYZ  at  $25  and  the  purchase  of  10  June  XYZ  25calls  at  $2.20.  In  this  trade,  you  have  –500  (5  × –100)  deltas  on  the short stock side and +500 (10 × +50) deltas on the options side for anoverall position delta of zero. If the stock moves up 5 points, its delta is  still  –500.  It  doesn’t  change,  because  it’s  ﬁxed.  The  only  time  itchanges is when you alter the position by selling existing, or purchasingadditional, shares.
The  variable  deltas  are  your  option  deltas.  The  ATM  calls  are  +50each.  If  the  underlying  stock  moves  up  5  points,  the  calls  become  in-the-money with a higher delta of approximately +70 each for a total of+700  deltas.  This  means  that  your  overall  position  delta  is  +200.  Tobring the trade back to delta neutral, you can make an adjustment by ei-ther  selling  200  shares  or  selling  three  of  the  ATM  calls  you  alreadyown. Either choice realizes an increased credit into your account. If themarket makes another move, you will be able to make another adjust-ment to increase your proﬁt even more. This adjustment process locksin proﬁts.
Adjustment Example #1
Let’s  explore  another  example  using  XYZ.  Suppose  the  stock  is  about  tobreak  out  or  move  above  its  all-time  high  of  $90  a  share.  You  decide  toplace a long synthetic straddle. With XYZ trading for $90, the July 90 callsare priced at $3.75 and the July 90 puts are priced at $2.75. You decide toinitiate a 5 × 10 position (i.e., 500 shares of XYZ stock and 10 XYZ options).Once again, you have to choose which options have a better proﬁt poten-tial: puts or calls. You decide to purchase the shares and buy ATM puts. Onthe stock side, you have +500 deltas, which will be offset by 10 long ATMJuly 90 puts for a total of –500. The overall position delta going into thistrade is a perfect zero. The total risk is the premium paid for the 10 putoptions, or $2,750.
On April 14, XYZ closes at $95. The July 90 calls close at $6.875 andthe July 90 puts close at $2. The positive delta is still +500. Since you areone strike out-of-the-money, the negative deltas have moved to –35 eachfor  total  deltas  of  –350.  Your  overall  position  delta  is  now  +150.  You
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make  an  adjustment  to  get  back  to  delta  neutral  by  selling  150  XYZshares for a proﬁt. Now you own 350 shares of XYZ and the 10 puts orig-inally purchased.
What is your cash settlement up to this point? Right now, it is rela-tively easy to calculate the cash settlement. You started with 500 sharesof XYZ at $90. Then the price went up 5 points and you sold 150 sharesfor a $750 proﬁt. The puts are now at $2. You lost .75 point on the puts,which  equals  $750.  That  means  you  have  broken  even  on  this  trade  sofar,  but  still  have  350  shares  of  XYZ  at  $90  showing  an  open  positionproﬁt of $1,750.
Market Opportunity: On April 11, XYZ breaks out of its all-time high of$90.
Strategy: Long  synthetic  straddle—limited  risk  and  unlimited  proﬁt potential.
Initial Trade: Long 500 Shares of XYZ @ 90, Long 10 July XYZ 90 Puts @2.75.
Initial Deltas: +500 and –500 = zero.
Move #1: April 14—XYZ moves to $95. July 90 puts close at $2.
Consequence #1: Puts are now one strike out-of-the-money for a total of–350 deltas. Overall position is now +150 deltas.
Adjustment #1: Sell 150 shares of XYZ at $95.
Cash Settlement: Selling 150 XYZ shares at $95 translates to a proﬁt of$750.  The  long  puts  are  now  at  $2,  which  is  a  loss  of  $.75  each.  Thisequates to a loss of $750. The total cash proﬁt so far is zero; however, the350 shares of XYZ at $90 do have an open position proﬁt of $1,750.
Move  #2: On  April  26,  XYZ  hits  $105  a  share.  July  90  puts  close  at$1.625.
Consequence #2: Puts are now three strikes out-of-the-money for a totalof –250 deltas. Overall position delta is now +100.
Adjustment #2: Sell 100 shares of XYZ at $105.
Cash Settlement: Selling 100 XYZ shares at $105 translates to a proﬁt of$1,500. The 10 long puts are now at $1.625, which translates to $1,625,a net loss of $1,125.
Total  Cash: The  additional  open  position  proﬁt  on  the  250  shares  pur-chased  at  $90  that  are  now  worth  $105  translates  to  $3,750  proﬁt.Adding this to the previous proﬁts creates a total of $6,000. The total putloss is $1,125. The total proﬁt on this trade equals $4,875.
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On  April  26,  XYZ  hits  $105  a  share.  The  July  90  calls  are  now  at$11.50  and  the  July  90  puts  are  now  going  for  $1.625.  Your  350  XYZshares have a positive delta of 350. The puts are now at –250 becauseyou’re  three  strikes  out  or  –25  each.  That  gives  you  a  position  delta of  +100.  Let’s  make  another  adjustment  by  selling  100  more  shares  ofXYZ at 105.
What is your cash settlement to date? You started with 500 shares ofXYZ at $90. You sold 150 at $95. You made $750 on that one trade. You stillown  a  lot  more  that  have  incurred  proﬁts  as  well.  You  just  haven’t  soldthem yet. Then, you sold another 100 shares at $105 making 15 points oneach. That gives you another $1,500. Now, you are still holding 250 sharesof  XYZ  stock  at  $90.  If  you  bought  250  shares  at  $90  and  now  XYZ  is  at$105, you have $3,750 in an open position proﬁt. This adds up to $6,000 onthe stock side of the straddle. Let’s take a look at the put side of the trade.You bought the puts for $2.75, which translates to $2,750. They are worthonly  $1,625  now,  which  means  you  have  lost  $1,125.  That  creates  a  netproﬁt of $4,875—a pretty healthy proﬁt.
Adjustment Example #2
Since a large trade ratio allows us to make even more adjustments, let’stry a 10 × 20 long synthetic straddle. On March 25, using XYZ trading at 30,we initiate the following trade: short 1,000 shares of XYZ at $30 and long20 June XYZ 30 calls at $3.50. Each call option costs $350 (3.50 × 100) for atotal debit of $7,000 (350 × 20).
Four  days  later,  the  market  moves  to  $35.  The  calls  are  now  worth$11.25 each and are now one strike in-the-money. This means that the 20long  calls  now  have  a  total  delta  of  +1,300,  creating  an  overall  positiondelta of +300. To return to delta neutral, we make an adjustment by selling300 more shares. We now have a position that is short 1,300 shares of XYZand long 20 June XYZ 30 calls.
Two days later, the market rises to $40. Once again, the long deltasincrease another +300. We sell 300 more shares to adjust the trade backto delta neutral. That gives us an open position of long 20 calls at $19,short 1,000 shares at $30, short 300 shares at $35, and short 300 sharesat $40.
Let’s  take  a  look  at  the  cash  settlement  to  date.  We  originally  sold1,000 shares at $30, incurring a credit of $30,000. We made our ﬁrst adjust-ment by selling 300 more shares at $35 for an additional credit of $10,500.Then we sold 300 shares at $40 or $12,000. This creates a total credit of$52,500.  However,  since  the  price  of  XYZ  has  been  increasing,  we  havelost the following on the shares with XYZ trading at $40.
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1,000 shares @ 30 = $30,000 = Loss of $10,000 @ 40.
300 shares @ 35 = $10,500 = Loss of $1,500 @ 40.
300 shares @ 40 = $12,000 = Loss of 0 @ 40.
Total loss on the shares = $11,500 @ 40.
On the other side, the long calls originally cost us $3.50 each for a to-tal debit of $7,000. They have increased in value to $19 or $1,900 each, fora total of $38,000. This creates a proﬁt on the call side of $31,000. If wereconcile  this  with  our  loss  on  the  stock  side,  we  have  total  proﬁt  of$19,500 ($31,000 – $11,500 = $19,500).
Market  Opportunity: On  March  25,  XYZ  is  ready  for  a  breakout  moveabove $40.
Strategy: Long  synthetic  straddle—limited  risk  and  unlimited  proﬁt potential.
Initial Trade: Short 1,000 Shares of XYZ @ 30 (Credit = $30,000), Long20 June XYZ 30 Calls @ 3.50 (Total debit = $7,000).
Initial Deltas: –1,000 and +1,000 = zero.
Move #1: March 29, XYZ moves to $35.
Consequence  #1: The  calls  are  now  one  strike  in-the-money,  whichmeans that the 20 long calls now have a total delta of +1,300. Overallposition delta is now +300.
Adjustment #1: To make an adjustment, sell 300 shares of XYZ at $35.The trade is now short 1,300 shares of XYZ and long 20 calls.
Move #2: On April 1, XYZ moves to $40.
Consequence #2: Long call deltas increase another +300.
Adjustment #2: Sell 300 shares of XYZ at $40. The trade is now long 20June XYZ calls at $19, short 1,000 shares of XYZ at $30, short 300 sharesof XYZ at $35, and short 300 shares of XYZ at $40.
Total  Cash: We  originally  sold  1,000  shares  of  XYZ,  incurring  a  loss  of$10,000. We made our ﬁrst adjustment by selling 300 more shares at $35for  a  loss  of  $1,500.  We  also  sold  300  shares  of  XYZ  at  $40,  but  sinceshares are still trading at $40, we have not incurred a proﬁt or a loss yet.This creates a total loss of $11,500. The long calls originally cost us $350each for a total debit of $7,000. They have increased in value to $19 or$1,900 each. That gives us a total of $38,000 for a proﬁt on the call sideof $31,000. If we reconcile this with our losses on the stock side, we havetotal proﬁt of $19,500 ($31,000 – $11,500 = $19,500).
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ADDITIONAL ISSUES
Can you make adjustments on 1 × 2 trades? Approximately 90 percent ofthe time, a 1 × 2 trader will not make any adjustments. The trade is simplyplaced and exited when the market moves. If an adjustment is possible, itwill most likely be made on the option side.
Frequently, when the market moves up fast and you see a dramatic in-crease in volatility, it can be better to get out of the trade altogether. Why?Because when you have an increase in the volatility, the premium on anoption  is  going  to  pump  up.  I  recommend  exiting  the  trade,  waiting  forvolatility to collapse a little, and then getting back in.
For example, if you have a 1 × 2 (100 shares × 2 options) or 2 × 4 (200shares × 4  options)  trade,  you  have  to  have  some  decent-sized  marketmovement, and a good proﬁt (i.e., 20 percent), before you even considermaking an adjustment. Why make an adjustment at all when you can justget  out  of  the  trade  and  then  get  back  into  the  trade  when  the  marketcalms down? If you can make a 20 percent return on your risk capital, youare on your way to healthy, consistent proﬁts.
What determines whether you initially go short or long the underlyingstock with the corresponding long two puts or long two calls? The way todecide is to look at the prices of the puts and calls and buy the ATM op-tions  that  are  the  cheapest.  You  could  be  looking  at  a  computer  or  youcould be looking at the newspaper at the end of the night. Let’s say XYZshares are trading at $48 and the 50 puts are $3.25. There is a $0.75 differ-ence between the price of the puts and the price of the calls. Therefore, Iwould rather pay $2.50 for the calls and buy two for each I sell. But it re-ally doesn’t matter which way you go to get to delta neutral. It is safe toassume that you want to take the less expensive of the two options andthereby pay less money out-of-pocket. Taking less money out of your ac-count initially is a good technique to use if you want to dramatically in-crease your account size. That’s where the real buried treasure lies, andit’s just waiting for you to discover it.
USING ADJUSTMENTS TO REPAIR A TRADE
The type of strategies that traders implement is a major factor that deter-mines their success or failure in this business; however, the ability to ad-just  positions  to  obtain  maximum  proﬁtability  is  what  separates  theprofessionals from the average trader. There have been situations where Ihave made changes to a position and then within in a couple of days real-ized that I had made the wrong decision. When you are faced with these
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