Delta hedging is a risk management strategy used in options trading. It involves offsetting the risk associated with price movements in the underlying asset by taking opposite positions.
The “delta” in delta hedging refers to the sensitivity of an option’s price to changes in the price of the underlying asset. It shows how much the price of an option is expected to change for every one-point move in the price of the underlying asset.
The strategy of delta hedging involves creating a delta neutral position by taking opposing positions in the market. For example, if an investor owns a call option on a certain stock, they could delta hedge by also selling a portion of the stock. Similarly, if the investor owns a put option, they might choose to also buy a portion of the stock.
In a delta neutral position, any losses on the option due to a change in the price of the underlying asset should be offset by gains made on the opposing position, and vice versa. This helps the investor to limit their potential losses.
The concept of delta hedging can become more complex when taking multiple variables into account, such as changes in volatility, interest rates, or time decay. At its basic level, however, it is a risk management strategy designed to offset the risk of price moves in the underlying asset.
