Delta Hedging

Delta Hedging

An options strategy that involves offsetting a long position on an option contract with a short position on the underlying asset, or vice versa. An investor uses a delta hedging strategy when a change in the price of the underlying asset results in a change to the premium of the option. The relationship between the change in premium and the change in the price of the underlying is known at the hedge ratio; delta hedging profits from changes in the hedge ratio.

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Delta Hedging

What Does Delta Hedging Mean?

An options strategy that aims to reduce (hedge) the risk associated with price movements in the underlying asset by offsetting long and short positions. For example, a long call position may be delta hedged by shorting the underlying stock. This strategy is based on the change in premium (the price of the option) caused by a change in the price of the underlying security. The change in premium for each basis-point change in the price of the underlying is the delta, and the relationship between the two movements is the hedge ratio.

Investopedia explains Delta Hedging

As an example, the price of a call option with a hedge ratio of 40 will rise 40% (of the stock-price move) if the price of the underlying stock increases. Typically, options with high hedge ratios are usually more profitable to buy than to write because the greater the percentage movement relative to the price of the underlying stock and the corresponding little time-value erosion, the greater the leverage. The opposite is true for options with a low hedge ratio.

Related Terms:
• Call Option
• Common Stock
• Delta
• Gamma
• Hedge