Delta Hedging

AAA

DEFINITION of 'Delta Hedging'

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 (price of option) caused by a change in the price of the underlying security. The change in premium for each basis-point change in price of the underlying is the delta and the relationship between the two movements is the hedge ratio.

VIDEO

Loading the player...

BREAKING DOWN 'Delta Hedging'

For 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 rather than write since the greater the percentage movement - relative to the underlying's price and the corresponding little time-value erosion - the greater the leverage. The opposite is true for options with a low hedge ratio.

RELATED TERMS
  1. Charm

    The rate at which the delta of an option or warrant will change ...
  2. Delta Spread

    An options trading strategy where the trader initially establishes ...
  3. Super Hedging

    A strategy that hedges positions with a self-financing trading ...
  4. Hedge Ratio

    1. A ratio comparing the value of a position protected via a ...
  5. Vega

    The measurement of an option's sensitivity to changes in the ...
  6. Greeks

    Dimensions of risk involved in taking a position in an option ...
Related Articles
  1. Investing Basics

    How Does Delta Hedging Work?

    Delta hedging is a derivative trading strategy that attempts to reduce -- or eliminate -- the risk caused by price changes in the underlying asset.
  2. Options & Futures

    Getting To Know The "Greeks"

    Understanding price influences on options positions requires learning about delta, theta, vega and gamma.
  3. Options & Futures

    Capturing Profits With Position-Delta Neutral Trading

    This trading strategy will show you how to gain from a decline in implied volatility on any movement of the underlying.
  4. Options & Futures

    Options Trading Strategies: Understanding Position Delta

    Learn more about the position delta hedge ratio and how it can tell you the number of contracts needed to hedge a position in the underlying asset.
  5. Stock Analysis

    Investors Need to Stop Shorting GoPro. Here's Why

    Discover why investors should stop shorting GoPro. GoPro has been one of the fastest-growing companies since 2005 with many betting against more growth.
  6. Chart Advisor

    Stocks to Short...When the Dust Settles

    Four short trades to consider, but not quite yet. Let the dust settle and wait for a pullback to resistance for a higher probability trade.
  7. Technical Indicators

    Using Moving Averages To Trade The Volatility Index (VIX)

    VIX moving averages smooth out the natural choppiness of the indicator, letting traders and market timers access reliable sentiment and volatility data.
  8. Stock Analysis

    3 Reasons to Short Monster Beverage

    Learn why, despite the popular perception of Monster Beverage as a high-growth stock, investors may be better off taking a short position on it.
  9. Forex Strategies

    How To Avoid Exchange Rate Risk

    What are the best strategies to avoid exchange rate risk when trading?
  10. Home & Auto

    When Getting a Rent-to-Own Car Makes Sense

    If your credit is bad, rent-to-own may be a better way to purchase a car than taking out a subprime loan – or it may not be. Get out your calculator.
RELATED FAQS
  1. What industries typically use delta hedging techniques?

    Those industries which are connected to the finance and commodity markets and are trading derivatives are the most likely ... Read Full Answer >>
  2. What are the differences between delta hedging and beta hedging?

    Hedging is used to reduce the risk of adverse price movements in an asset class by taking an offsetting position in a related ... Read Full Answer >>
  3. Is there a better metric for hedging options than delta?

    Delta hedging is a way traders mitigate risk in their positions by taking an offsetting position. Although it is a common ... Read Full Answer >>
  4. What are the limitations of using delta to hedge options?

    Delta hedging is a strategy used to mitigate the risk associated with the price move in the underlying asset of an option ... Read Full Answer >>
  5. How can you use delta to determine how to hedge options?

    The delta of a derivative security tells you the relationship between the underlying security's price and the security's ... Read Full Answer >>
  6. What questions are commonly asked during a portfolio management job interview?

    A portfolio manager is a person who is responsible for making investment decisions using money that other investors place ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Alligator Spread

    An unprofitable spread that occurs as a result of large commissions charged on the transaction, regardless of favorable market ...
  2. Tiger Cub Economies

    The four Southeast Asian economies of Indonesia, Malaysia, the Philippines and Thailand. Tiger cub economy indicates that ...
  3. Gorilla

    A company that dominates an industry without having a complete monopoly. A gorilla firm has large control of the pricing ...
  4. Elephants

    Slang for large institutions that have the funds to make high volumes trades. Due to the large volumes of stock that elephants ...
  5. Widow's Exemption

    In general terms, a widow's exemption refers to the amount that can be deducted from taxable income by a widow, thereby reducing ...
  6. Wedding Warrant

    A warrant that can only be exercised if the host asset, typically a bond or preferred stock, is surrendered. Until the call ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!