How Can You Use Delta to Determine How to Hedge Options?

The delta of an option tells you the relationship between the underlying security's price and the option's price itself.”

The delta represents the amount the price of the derivative will change when there is a change in the underlying price. For example, suppose you buy a call option with a delta of 0.2. The call option will increase by 20 cents for every $1 increase in the price of the underlying asset.

The delta of an option helps you determine the quantity of the underlying asset to buy or sell. This is known as delta hedging. Delta hedging involves trading another security to create a delta-neutral position, or a position that has a zero delta.

You can use delta to hedge options by first determining whether to buy or sell the underlying asset. When you buy calls or sell puts, you sell the underlying asset. You buy the underlying asset when you sell calls or buy puts. Put options have a negative delta, while call options have a positive.

For example, suppose you buy 15 call option contracts with a delta of 0.2. You are long delta, so you must sell deltas to create a delta-neutral position. Next, you need to find the quantity of the underlying asset you need to hedge. To find the delta hedge quantity, you multiply the absolute value of the delta by the number of option contracts and multiply that by 100 (each option contract controls 100 shares of stock). In this case, the quantity is 300, or equal to (0.20 x 15 x 100). Therefore, you must sell this amount of the underlying asset to be delta neutral.

Correction—April 17, 2023: The definition of a delta of 0.20 has been corrected to indicate it refers to an increase of 20 cents.