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 Delta Hedging Principles
Issued on February 08 2010 par Strategies-options.com
Delta hedging is a way to cover asset move exposure of a portfolio.
We saw that delta ∆ is a number that makes possible to grasp how would react a portfolio for a small variation of the underlying asset. It can be seen as the 'spot equivalent' exposure for a short period of a portfolio.
   Options are sensible to the spot, and delta shows up that sensitivity. I - Delta and replication Imagine that one gets the true future volatility of an asset and the true future interest rates for a given period. As far as there is a 'spot' component embedded in an option value, it may be possible to 'replicate' an option value at every moment, for a small period, provided volatility and interest rate are right. This means that if an option has a delta of 0.68, one is able to replicate 100 calls by buying 0.68 * 100 =68 shares on the market. Conversely, 400 shares XYZ can be replicated by buying 800 calls with delta at 50%. II - Advantage of the replication Replicating an option means being able to match its risk, hence to be able to make a market on that product. It improves markets and options liquidity. Summary : a first approximation Option Price Variation = ∆ * Spot Variation Delta hedging is a process that is not perfect. It leads to adjust the position and that could be costly. In order to avoid too high costs, it's sometimes needed to gamma hedge. Next : Gamma Hedging : A First Attempt Previous : Volatility Arbitrage Hedging : Principles Delta Hedging Principles Gamma Hedging Principles Vega Hedging Principles Hedging : A First Attempt Delta Hedging : A First Attempt Gamma Hedging : A First Attempt Hedging Delta Hedging Related Pdf : - Delta Hedging with the Smile - Delta Hedge - Delta Hedging Strategies-options.com |
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