Delta-neutral trading is a growing requirement for buy-sides: How can brokers respond?

Key Takeaways

• Buy-sides seek to achieve delta-neutral outcomes as part of both risk management and profit-seeking strategies.
• Delta-neutral trading strategies require access to a broad range of assets and automated trading tools.
• Comprehensive technological solutions are key to supporting sell-side brokers in delivering delta-neutral trading services to their clients.

Delta-neutral trading has become a key trading strategy for buy-side investment firms around the world. Balancing the deltas across an entire portfolio helps asset managers mitigate the risks associated with market volatility. But delta-neutral strategies require close monitoring, frequent adjustments, and access to a range of asset classes and instruments. For the sell-sides tasked with successfully implementing them, this presents major challenges. Advanced trading solutions are vital to delivering an efficient and cost-effective delta-neutral service, and they can also add value in a range of different areas.

What is delta-neutral trading?

The term delta-neutral trading describes strategies that aim to achieve a total delta of zero across an entire portfolio. The intended result is for the total portfolio value to remain unchanged, regardless of the directional price movements in the various underlying assets. The strategy combines positions with positive and negative delta to achieve market neutrality. In essence, delta-neutral trading strategies aim to mitigate the impact of price fluctuations on a portfolio’s value. By carefully combining long and short positions, traders can offset potential gains and losses, creating a hedge against market volatility. This approach allows for more predictable returns, and reduces the risk associated with sudden market shifts. Investors want to achieve market neutrality when trading in this way.

Why do buy-side firms use delta-neutral trading strategies?

For buy-side investment firms, there are two high-level motivations for delta-neutral trading strategies:

• Risk management and hedging: By balancing the value of positions across a portfolio to achieve a delta of zero, investors can minimize exposure to price movements in the underlying asset and protect the portfolio from market volatility. Delta-neutral strategies can also be used to hedge other investments. For example, if an investor holds a large position in a stock, they might use options to create a delta-neutral position to protect against short-term price fluctuations.
• Profit seeking: Delta-neutral strategies can generate profit in various ways, including from changes in implied volatility or from time decay of options within a portfolio.

Whatever a firm’s reasons for aiming at delta-neutrality, such strategies are demanding to implement. Portfolios need to be closely monitored and frequently rebalanced. Delta-neutral trading also requires access to a wide range of different asset classes and instruments (such as options, FX, and swaps), as this provides more alternative choices for offsetting market movements and achieving market neutrality.

How can sell-sides support delta-neutral trading

Sell-side firms, tasked with achieving delta-neutrality on behalf of their buy-side clients, face an additional challenge. How can they deliver these demanding requirements while maintaining operational efficiency? Technological solutions are crucial for firms seeking to deliver a comprehensive delta-neutral service while controlling their costs. Such solutions can be applied at various stages of the trade lifecycle.

One of the key requirements for delta-neutral trading is access to a wide range of assets and instruments. Being able to assemble a diverse portfolio makes it easier to include complimentary instruments and achieve a neutral outcome. Solutions that enable this access and that also empower automated cross-venue order management are therefore crucial.

Tools that enable bulk order management are also a vital aid to delta-neutral strategies. The ability to enter and manage multiple orders as a single basket can allow traders to carry out the large-scale actions required to maintain a neutral portfolio more efficiently. It’s also useful to be able to track and measure the performance of the basket against specific benchmarks, such as previous close. Algos that automatically maintain set price and volume targets make it easier for traders to manage large positions and achieve delta-neutral outcomes.

Automation is also important for supporting the process of rebalancing a delta-neutral portfolio. Again, traders should be able to set detailed targets and parameters for this process. For example, it’s useful to be able to target the least liquid assets as the highest priority for trading. Having access to detailed market data and metrics also supports this process.

While low-touch automated tools are vital for managing the workload required for delta-neutral trading, there are always going to be occasions when traders need to intervene. It’s important that technological solutions support this, not only by providing tools to enable manual intervention, but also by providing effective monitoring and alerting to help traders identify when algos are off target.

Conclusion

Delta-neutral trading is a vital strategy for buy-side firms to manage risk and seek profits in volatile markets. However, its implementation is complex and sell-sides need sophisticated tools to deliver delta-neutrality successfully.

The ION Fidessa solution supports delta-neutral trading in a range of ways. It can enable access to a wide range of different asset classes (such as equities, swaps, and FX), providing more options for building neutral portfolios. Fidessa also empowers streamlined order workflows through automation, including tools designed to manage orders in bulk, like Fidessa Baskets. Fidessa can deliver the insights needed to ensure that delta-neutral execution is achieved, with integrated monitoring and risk management functionality.

In a competitive environment, sell-side firms face challenges to provide efficient and cost-effective delta-neutral trading services. By applying advanced technology solutions, such as specialist trading software for brokers, they can deliver the automation and diverse market access required.