Delta Hedging

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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.

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.

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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 >>
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    The delta of a derivative security tells you the relationship between the underlying security's price and the security's ... Read Full Answer >>
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