Delta Hedging

Delta hedging is a technique used in order to hedge, i.e.protect, the value of a portfolio against small price movements in the underlying asset. Its objective is to have a net zero delta for a portfolio that consists of a combination of options, underlying and/or futures/forwards. If, say, a stock option covers 100 underlying shares, buying one call option with a delta of 0.10 is a proxy for being long 10 shares. To delta hedge the position would involve selling 10 shares. For small price changes the value of the position would be unchanged irrespective of which way the price moved. Delta changes continuously as the market moves up and down, as option implied volatilities shift and the time to expiry reduces. Consequently, delta hedging needs in theory to be conducted dynamically, such that the hedge ratio is always at or close to zero.

Related terms