Loading the player...

What is 'Delta Hedging'

Delta hedging is an options strategy that aims to reduce, or 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, or price of option, caused by a change in the price of the underlying security.

BREAKING DOWN 'Delta Hedging'

The theoretical change in premium for each basis point or $1 change in price of the underlying is the delta, and the relationship between the two movements is the hedge ratio. The price of a put option with a delta of -0.50 is expected to rise by 50 cents if the underlying asset falls by $1. The opposite is true as well. The delta of a call option ranges between zero and one, while the delta of a put option ranges between negative one and zero. For example, the price of a call option with a hedge ratio of 0.40 will rise 40% of the stock-price move if the price of the underlying stock increases by $1.

Options with high hedge ratios are usually more profitable to buy than to 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.

Delta Hedging With Options

An options position could be hedged with options with a delta that is opposite to that of the current options position to maintain a delta neutral position. A delta neutral position is one in which the overall delta is zero, which minimizes the options' price movements in relation to the underlying asset. For example, assume an investor holds one call option with a delta of 0.50, which indicates the option is at-the-money, and wishes to maintain a delta neutral position. The investor could purchase an at-the-money put option with a delta of -0.50 to offset the positive delta, which would make the position have a delta of zero.

Delta Hedging With Stock

An options position could also be delta hedged using shares of the underlying stock. One share of the underlying stock has a delta of one because the value changes by $1 given a $1 change in the stock. For example, assume an investor is long one call option on a stock with a delta of 0.75, or 75 since options have a multiplier of 100. The investor could delta hedge the call option by shorting 75 shares of the underlying stocks. Conversely, assume an investor is long one put option on a stock with a delta of -0.75, or -75. The investor would maintain a delta neutral position by purchasing 75 shares of the underlying stock.

Pros and Cons of Delta Hedging

One of the primary drawbacks of delta hedging is the necessity of constantly watching and adjusting positions involved. Depending on the movement of the stock, the trader has to frequently buy and sell securities in order to avoid being under or overhedged. It can also be expensive. It is particularly when the hedging is done with options, as these can lose time value, sometimes trading lower than the underlying stock has increased. Trading fees apply to the trades made to adjust the position as well. Delta hedging primarily benefits the trader when they anticipate a strong move coming, as it primarily protects the investor from small moves. 

  1. Delta-Gamma Hedging

    Delta-gamma hedging is an options strategy combining delta and ...
  2. Delta

    Delta is the ratio comparing the change in the price of the underlying ...
  3. Stock Replacement Strategy

    Stock replacement is trading strategy that involves replacing ...
  4. Pinning the Strike

    Pinning the strike is the tendency of an underlying security's ...
  5. Inflation Hedge

    An inflation hedge is an investment that is considered to provide ...
  6. Hedge

    A hedge is an investment to reduce the risk of adverse price ...
Related Articles
  1. Insights

    Delta Releases Operating Expense Figures for Q4 and 2016 (DAL)

    Delta’s operating expenses for Q4 and 2016 are down from the previous year despite increased labor costs.
  2. Investing

    Delta Air Lines Announces Another Big Buyback (DAL)

    Two years ago, Delta Air Lines (NYSE: DAL) marked the beginning of a new era in the airline industry when it began paying a $0.06 quarterly dividend and announced a $500 million share buyback ...
  3. Investing

    DAL: How Delta's Stock Price Fell 26% in 6 Months

    Delta's stock price has been punished over the last six months due to higher oil prices, the Brexit vote and its own outages that stranded passengers.
  4. Insights

    Delta Releases Q4 & 2016 Revenue Figures (DAL)

    Delta’s revenue figures for Q4 and 2016 are down from the previous year, mostly due to declines in passenger revenue.
  5. Insights

    Delta and American File Objections and Responses over LAX-PEK Route (DAL, AAL)

    Delta is fighting the Department of Transportation’s tentative decision to award the Los Angeles-Beijing route to American Airlines.
  6. Trading

    Using Options Tools To Trade Foreign-Exchange Spot

    Find out how delta, gamma, risk reversals and volatility can all help predict movements in the cash market.
  7. Investing

    Best Airline Returns: Delta, Southwest, or Alaska? (ALK, DAL)

    If it's spring, then it's time for airlines to roll out their new dividend and buyback plans. Indeed, it's been a busy month for airline investors, as Delta Air Lines (NYSE: DAL), Southwest ...
  8. Insights

    Delta Purchases Five New Heathrow Slots (DAL)

    Delta paid $19 million for five pairs of morning slots at the London Heathrow Airport despite two consecutive years of negative growth in the trans-Atlantic market.
  9. Managing Wealth

    United Airlines vs. Delta First Class: Which Is Better?

    Both airlines allow you to check two free bags to most destinations when you fly first class, but baggage isn’t everything.
  1. What are common delta hedging strategies?

    Learn about common delta hedging strategies, including how to make a position in options delta neutral by offsetting risk ... Read Answer >>
  2. How can you use delta to determine how to hedge options?

    Learn what delta is, how to use delta to hedge options and how to maintain a delta-neutral position by delta-hedging options ... Read Answer >>
  3. What is spread hedging?

    Learn about one of the most common risk-management strategies options traders use, called spread hedging, to limit exposure ... Read Answer >>
Trading Center