Delta Hedging – Options Trading Strategy

Delta hedging is an option strategy whose goal is to limit the risk associated with price movements in the underlying stock, by offsetting long and short positions.

Like other hedging strategies, delta hedging is a good tool to use to minimize, or eliminate, potential loss in an investment. By reading this article, investors will gain a basic understanding of this strategy and be able to implement it into their investing playbook.

Delta is the theoretical change in option price for each $1 change in the underlying stock’s price. For example, a call option with a delta of 0.50 will theoretically increase in price by $0.50 with every $1 increase in the underlying stock’s price. For a put option, a delta of -0.50 will increase the option’s price by $0.50 with every $1 decrease in the underlying stock’s price. The delta of a call option ranges from 0 to 1 whereas the delta of a put option ranges from -1 to 0.

Delta hedging is when an option position is hedged with another option position that has an opposite delta value. This creates a delta neutral position, in which the overall delta value is zero. In a delta neutral position, a change in the underlying stock’s price will not affect the option’s price.

For example, assume an investor holds a call option with a delta of 0.40 and wants to establish a delta neutral position. He could do this by buying a put option with a delta of -0.40. By purchasing these options, the investor establishes a delta neutral position.

An option position could also be delta hedged by using shares of the underlying stock. A share of stock has a delta of 1 since the value of the stock increases by $1 with every $1 increase in the stock.

For example, assume an investor owns a call option with a delta of 0.60. This investor could delta hedge the position by shorting 60 shares of the underlying stock. Alternatively, assume an investor owns a put option with a delta of -.60. In this case, a delta hedge could be established if the investor buys 60 shares of the underlying stock.

Whether a delta hedge is established using options or stocks, it is a great strategy to use to minimize risk associated with a change in an option’s price. After reading this article, investors should feel confident to use this strategy when trading options.